With each passing year, more and more small business owners decide to register their organizations as Limited Liability Companies, or LLCs. In fact, numbers from the IRS indicate that there are now more than 21 million LLCs operating in the United States.
It's not difficult to understand why the LLC is such a popular format for business owners. There are a number of benefits to the LLC structure, including personal liability protections that other legal designations (e.g., Sole Proprietorship) do not match. LLCs also provide tax flexibility and managerial flexibility, both of which make it more appealing than incorporation.
But of course, with these advantages, there are also some important responsibilities… first and foremost, a responsibility to practice smart, strategic LLC accounting.
Setting Up LLC Accounting: Some Basics
Simply put, careful accounting helps you to preserve the robust personal liability protections that your LLC offers, specifically by keeping your business assets/liabilities separate from your personal ones. By contrast, if you get sloppy with your accounting practices, it can potentially compromise those protections, which can be truly costly for you and your business.
There are a couple of common errors that can jeopardize your LLC's personal liability protections. Those errors are moving your money around without the right documentation, and failing to file the appropriate forms with your state or with the federal government. Another, even more grievous pitfall is using personal assets to pay business expenses, or vice versa; this can truly damage your LLC's legal standing.
By properly setting up your LLC accounting standards, you can significantly reduce the risks of these and other errors. Some tips include:
Get an EIN and Establish a Business Bank Account
First and foremost, get an employer identification number, or EIN, for your business. You can apply for one from the IRS, and if you're a U.S. citizen, it won't cost you a thing.
With your EIN, you'll be able to sign up for savings, checking, and credit accounts in your business' name. Be careful not to link these accounts with your personal banking needs!
Select Your Accounting Method
You'll also need to choose an accounting method for your LLC, which likely means either cash-based accounting or accrual-based.
Cash basis accounting is the most popular option among small business owners, as it tends to be pretty simple. With cash basis accounting, you only add money to your books when you receive that money, and you only deduct it when you actually pay it out.
Meanwhile, with an accrual basis, you record all income and expenses when the transaction takes place, irrespective of when money changes hands. In other words, if you invoice a customer in April, you'd record the transaction in your ledger then and there, even if the invoice doesn't get paid until July.
Set Up Your Ledger
The next step is to establish your general ledger, which is the foundation of basically all small business accounting. Your general ledger serves as a record of all financial transactions conducted on behalf of your business. These transactions are not only logged, but placed into one of five different categories:
Your general ledger allows you to maintain and organize your LLC's entire financial history. Without a general ledger, you won't be able to apply for financing, to prepare for audits, or even to balance your books.
Paying Taxes for Your LLC
Beyond setting up these basic accounting practices, it's also important to understand how LLCs pay their taxes. Naturally, tax prep is one of the most significant accounting activities of all, and LLCs provide a few unique options to consider.
If you have a single-member LLC, the IRS will default to pass-through taxation. This basically means you'll declare all business profits on your personal tax return, and pay your normal tax rate. For multi-member LLCs, the default policy is to tax you as a Partnership, which works in much the same way, only with profits allocated between members in accordance with your Operating Agreement.
Note that an LLC can also elect to be taxed as a Corporation, paying the corporate tax rate. This is not always advantageous but in select cases may work well as part of a broader tax strategy.
Additional Accounting Practices for LLCs
There are a few additional accounting basics that every LLC owner should be aware of.
Every state requires LLCs to have Registered Agents. The purpose of these Agents is to receive, maintain, and organize all legal and tax documents on behalf of your LLC.
While some states will allow you to serve as your own Registered Agent, most don't. Having a third-party vendor is best anyway, as it frees you to spend more time running your business, less time filing paperwork.
There are plenty of Registered Agent services available in each state; Northwest Registered Agent is one of the most popular options.
It goes without saying that the accounting process goes much more smoothly when you invest in the right technology. For most LLCs, staples like QuickBooks work just fine. Be sure that, whatever technology you choose, it's secure and it's cloud-based.
Separation of Funds
It cannot be stressed enough that the best way to maintain your LLC's personal liability protections is to keep your business and personal funds separate. The rule of thumb here is:
Never use your business funds to pay personal expenses.
Never use your personal funds to pay business expenses.
Following this basic premise should help you steer clear of the most serious LLC accounting errors.
For LLCs, Smart Accounting is Essential
Every business benefits from good financial stewardship, but LLCs have a particular need for practical accounting methods. Use these guidelines to keep your LLC accounting practices on track.