One possible source of funding for contractors is a personal line of credit. While it can be easier to get personal credit, it might not be the best option. Under certain circumstances, the borrower’s credit can be damaged or tax deductions may have to be forfeited.

According to the National Small Business Association (NSBA), 35% of small business owners said that a lack of capital is hindering their ability to grow their business or expand operations and 19% said they had to reduce headcount as a result of tight credit. These findings were conveyed in pre-pandemic data collected by NSBA and released in its 2018 Mid-Year Economic Report. Although dated, it is the most recent data available from NSBA and the findings are in line with previous studies.

NSBA data supports that insufficient or delayed financing remains a common reason for small business failure. Contractors could be forced to finance the business with personal credit to meet payroll and cover expenses.

Difference Between a Personal and Business Line of Credit

A personal line of credit is good to have if money is needed quickly. It is an unsecured loan that is similar to a credit card account, but often carries a more favorable interest rate. There is a maximum credit limit and funds can be accessed via debit card, account transfer or check.

A Social Security Number identifies a personal line of credit borrower for tax purposes and an employer identification number (EIN) or Tax Identification Number (TIN) identifies a business borrower.

Personal and Business Credit Scores

A business credit score and a FICO score are evaluations of a consumer’s credit worthiness. A FICO score measures personal credit worthiness, where a business credit score represents a company’s creditworthiness, according to Business Credit Score 101.

A person's credit score is calculated with software from Fair Isaac Corporation (FICO). Personal FICO scores range from 300 to 850. A good FICO score is typically considered 720 or higher.

Information from Dun & Bradstreet, Equifax and Experian is used to produce a score to predict how likely it is that a company will pay them back in a timely fashion. This is their business credit score. It generally ranges from zero to 100. A business credit score of 75 is typically acceptable for many lenders.

A FICO score is derived from a consistent formula, while a business credit score is determined by varying formulas depending on the lender. A higher score means the business has a history of paying bills on time. Contractors with high business credit scores are more likely to secure a loan or line of credit with favorable terms while businesses with poor credit ratings face higher interest rates.

Pros and Cons

As with any business decision, the pros and cons of using a personal versus a business line of credit must be considered. While it might be quick and easy to obtain a personal line of credit, a borrower’s credit score can be damaged if the company becomes highly leveraged or falls behind on payments.

Business expenses are generally tax deductible provided they are necessary, such as equipment, inventory and supplies. Contractors must keep accurate records of business expenses and payments for tax purposes. Certain purchases may qualify for bonus depreciation if they were paid for with a business line of credit.

A contractor may deduct interest if a business line of credit was used to pay for the goods or services. This is not an option if a personal line of credit is used.

Small business owners should separate business from personal expenses. It is important to document expenses and payment methods. Using a business line of credit to pay for personal expenses should be avoided. It can raise a red flag for the IRS to audit business and/or personal tax returns.