How To Do Accounting for an LLC: Everything You Need To Know
How to do accounting for an LLC is an essential skill for new limited liability company owners.3 min read
2. The General Ledger
3. Choosing Tax Treatment
4. Steps To Set Up Accounting
5. Accounting Methods
Updated July 14, 2020:
How to do accounting for an LLC is an essential skill for new limited liability company owners. This type of state-authorized business entity provides tax advantages for sole proprietors and partners without the managerial restraints of a corporation.
Administering a New LLC
Sales, marketing, and accounting are all key administrative areas for new LLC owners (known as members). Accounting is especially important to preserve limited liability, which protects personal assets from being seized to satisfy debts and obligations of the business. LLCs are not taxed at the corporate level, which makes them an advantageous choice for many small business owners.
LLCs are subject to fewer record-keeping requirements than corporations must follow. Certain states require the filing of an annual report, but others do not.
Before establishing an LLC, you should seek the advice of a qualified tax professional who can explain how this entity is taxed at the state and federal levels. An LLC is treated as a pass-through entity by default, which means profits and losses are reported on each member's individual tax return. Many LLC owners will also be subject to self-employment tax. State LLC taxes vary by state as well as by the type of business.
The General Ledger
As with most types of businesses, the general ledger forms the accounting foundation of an LLC. Similar to a personal checkbook, this record shows the daily transactions of the business. In addition to cash, the general ledger also details investment assets, real estate, valuable equipment, and other assets, as well as lines of credit, loans, and other liabilities.
Having a comprehensive general ledger provides a picture of every financial transaction associated with the business. Depending on your industry, this information may be important for regulatory purposes. You'll also need this documentation if you are trying to sell the business or seeking investor capital.
Choosing Tax Treatment
Before establishing a comprehensive accounting system, you'll need to establish the tax treatment for LLC. You can choose to be taxed as a corporation, partnership, or sole proprietorship, and must make this election when you form the company. If you're using accounting software like Quickbooks, select the entity type for your tax treatment, not LLC.
Pass-through entities, including partnerships and sole proprietorships, must deposit employment taxes at both the state and federal levels.
At the end of the year, your federal income tax return will need to include a Schedule C if you are a sole proprietorship, Form 1065 for partnerships, and Form 1120 if your LLC is taxed as a corporation.
Steps To Set Up Accounting
- Create a chart of accounts, including all your business expenses, revenue, assets, liability, and owner equity accounts.
- Record all transactions, including received income, written checks, withdrawn equity, and added equity. This is done with a notation known as a journal entry.
- Strive to balance your books as evidenced by the equation Assets (A) = Liabilities (L) + Equity (E).
You'll need to decide between the accrual basis or the cash basis accounting method for your business. Each has advantages and disadvantages so it's important to understand both methods before moving forward.
With the cash method, you do not deduct expenses until they are paid and do not add cash until it is actually received. This is popular among small businesses thanks to its simplicity.
With the accrual method, you record expenses when the service or product is received and income when the sale occurs. For example, if you invoice a client for a project in December and don't get paid until March, you would record the income in March if you use the cash method and in December if you use the accrual method. The accrual method provides a more accurate monthly picture of your business's expenses and revenue.
Although the cash method is not as accurate as the accrual method, it has the advantage of delaying taxes until you have the funds in hand. With the example above, the income from that project would be taxed in 2020 even though you won't receive it until 2021 under the accrual method. With the cash method, the income would be taxed in 2021 when it actually hits your books.
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