A Complete Guide to LLC Accounting
Every year, more and more small business owners structure their companies as a limited liability company (LLC).
In fact, the number of registered LLCs has grown every year since 2004, according to data from the Internal Revenue Service (IRS). And according to estimates, there were close to 21.6 million LLCs operating in the U.S. in 2021.
It’s easy to see why this business structure is so popular. With an LLC, you get the legal and financial protection of a corporation with the financial and structural flexibility of a sole proprietorship. The main LLC benefits include:
- Liability protection: The legal structure of your LLC guarantees that your personal assets won’t be at risk in the event of a lawsuit, business debt, or bankruptcy.
- Taxation flexibility: You can choose whether you want to be taxed as an LLC or a corporation. If taxed as an LLC, you pay personal income taxes for your share of the business and can qualify for special tax deductions of up to 20% of your net business income.
- Structural flexibility: Your LLC can have as many owners (known as members) as you want it to have. Owners of an LLC can choose to manage the business themselves, hire an outside person to manage the company, or a combination of both.
With flexibility and independence also comes responsibility—particularly when it comes to your LLC accounting.
How to set up your LLC accounting
Careful accounting helps you preserve the limited liability that LLCs enjoy, while sloppy accounting puts your personal assets at risk.
Some common pitfalls that can lead to a court determining you’ve failed to maintain limited liability include:
- Moving money around without documentation
- Failing to file the right forms with state and federal authorities
Here’s what you should do to set up your LLC accounting properly and avoid similar missteps.
Open separate business accounts
Open separate banking, checking, and credit card accounts in the name of your company using the tax ID number. Don’t link these accounts with your personal transactions.
Your LLC is a separate business entity, both legally and financially. Yes, you can transfer money to your company from your personal account. And your LLC can pay you for your role as the owner or an employee.
However, commingling assets opens you up to potential problems with the IRS, creditors, and courts. What does that mean? It means don’t buy your children birthday presents with your business credit card and don’t pay your LLC’s phone bill with your personal credit card. As The Offspring say, “you gotta keep ‘em separated.”
When all your expenses are being paid with one business account or card, you’re also making it much easier to keep detailed records. Clean records of your business expenses also help you take advantage of the small business tax deductions you’re entitled to as an LLC member.
Decide on an accounting method
There are two accounting systems you can choose for your LLC: cash basis and accrual basis.
- Cash basis accounting: You don’t add cash to your books until you’ve received the money, and you don’t deduct any expenses until they’re actually paid. Small businesses often prefer this method because of its simplicity.
- Accrual basis accounting: You record your income and expenses when the transaction occurs, regardless of when the payment is sent.
Say you sent an invoice to your client in April but didn’t receive the payment until June. You would record this income in June if you’re using the cash method and in April if you’re using the accrual method.
Set up a general ledger
The general ledger is the accounting foundation of all businesses, LLCs included. It’s a record of all of your business transactions broken up and categorized into five different accounts: assets, liabilities, expenses, revenue, and equity.
The general ledger holds all of your business’s crucial financial information and enables you to organize and manage it. Without a general ledger, it’s difficult—if not impossible—to balance your books, apply for loans, or prepare yourself for an audit.
While general ledgers were once massive books full of handwritten financial records, most businesses have digitized the record-keeping process—using either spreadsheets or bookkeeping software (like Neat) for financial document management.
How LLCs pay taxes
Along with setting up your LLC accounting, you’ll need to decide how you want to be taxed. There are three ways the IRS can treat your LLC come tax time.
If you’re the only owner of your LLC, the IRS will tax your business as a sole proprietorship—meaning you, as the sole proprietor, will pay taxes for your LLC on your personal 1040 tax return.
If your LLC has multiple owners, the IRS will treat it as a partnership. Each owner must pay taxes on their personal income tax returns based on the profit share they own in the LLC.
You’ll also have to attach a Schedule E to your 1040 form, which is used to report income for partnerships. Your LLC operating agreement should clearly state the percentage of shares that each LLC member owns.
Even though the LLC doesn’t pay taxes as a corporate entity, it still needs to file Form 1065. The partnership files this form to show the IRS that all LLC members are reporting their income and losses correctly. The LLC must also file a Schedule K-1 that breaks down every member’s share percentage.
Any LLC can choose to be treated like a corporation for tax purposes by filing Form 8832 and checking the “corporate tax treatment” box.
If you’re in a higher tax bracket and paying 30+% on your personal income, choosing to be taxed as a corporation could save you money. The IRS taxes all regular corporations (C corporation) at a flat 21% rate.
However, LLCs with multiple owners that decide to go this route are essentially taxed twice. The LLC pays the 21% corporate tax, and each shareholder pays income tax on their dividends at capital gains rates, which can also be 20+%.
The IRS’s website is always the best place to find the latest and most detailed information regarding LLC taxation.
Simplify LCC accounting with the right bookkeeping software
Whether or not you hire an accounting firm, you still need a system that gives you a clear and easy overview of your LLC’s finances.
The Neat Company provides just that. You can organize and store your financial documents securely in the cloud, invoice clients and track payments effortlessly, and easily gauge the financial health of your LLC with crystal clear reporting.
Start a free trial today to see why Neat is the go-to accounting software for thousands of small business owners, freelancers, and entrepreneurs.
March 31st, 2022
June 26th, 2020