Limited liability companies are wonderful tools for small business entrepreneurs but their flexibility sometimes makes the bookkeeping complicated. Fortunately, you can follow a few simple rules to account for the amounts paid to the owners of a limited liability company.
Payments to Owners of Single Member Limited Liability Companies
Typically, the single member limited liability company is treated for income tax purposes as a sole proprietorship. When that's the case, the payments to the LLC owner should be treated as owner draws. And that's usually pretty easy to do.
If you're using a small business accounting program like QuickBooks or Microsoft's Small Business Accounting, the default chart of accounts provides an "owner draws" account.
If you're using a checkbook program like Quicken or Microsoft Money, you can just create an expense category called something like "draw," but note that amounts paid to the owner of a sole proprietorship aren't expenses. The draws don't get deducted on the proprietorship's tax return... nor does the draw get counted as income.
Fortunately, the one owner limited liability company does not need to file any special tax return (other than the two-page Schedule C form that goes with the proprietor's individual tax return).
Payments to Partners in Multiple Member Limited Liability Companies
In the case of a multiple member limited liability company, the LLC is typically treated as a partnership for tax accounting purposes. And this means that partnership accounting rules apply.
Amounts paid to partners for their work (like a salary) are called guaranteed payments and should be categorized using an expense category or expense account that uses a label such as "guaranteed payments." These guaranteed payments actually are deducted as business expenses on the partnership's tax return.
Amounts paid to members after paying the guaranteed payments are accounted for as partner draws. As noted earlier in the discussion of how to treat owner draws in the case of a single member LLC, both QuickBooks and Microsoft's Small Business Accounting provide an "owner draws" account. (Sometimes the account will be called "partner draws," too, depending on how the accounting software is set up.)
The amounts paid to partners in an LLC treated as a partnership get reported on a K-1. The K-1 is included with the partnership's tax return. Each individual partner also gets a K-1 to show what he or she received.
Payments to Owners of LLCs Electing Corporation Status
One of the reasons that accountants and attorneys love the limited liability company option is because LLCs can elect to be treated (for tax purposes) as either a C corporation or as an S corporation. But when an LLC makes one of these elections--and it doesn't matter whether the LLC has a single owner or multiple owners--the rules for paying the owners get more complicated.
Amounts paid to a limited liability company member for his or her work should be treated as payroll. In other words, the amounts should be treated as regular old wages. For example, the employer (that is, the LLC) should deduct employee-paid payroll and income taxes from the payment. The employer would also calculate and then pay employer payroll taxes. LLC owners working as employees should also receive a W-2 at the end of the year to report any payroll they earned.
Amounts paid to an LLC owner for his or her ownership interest--this would be after any payment for wages--gets reported as a distribution or a dividend. Distributions and dividends are the corporation equivalents of owner draws in a sole proprietorship and partner draws in a partnership.
S corporations pay distributions. These distributions are reported to the Internal Revenue Service, the equivalent state revenue agency, and to the shareholder receiving the distribution using a K-1.
Traditional corporations, also know as C corporations, pay dividends. These dividends get reported to the IRS and to the shareholder receiving the dividend using a 1099-DIV.
Both distributions and dividends are accounted for in a manner similar to owner or partner draws by your accounting software.
When the name of a company ends with L.L.C/LLC, it is a legal form of business which is incorporated as a company and offers restricted liability to its members. Limited liability means that a person investing in the business can face a loss which is upto a maximum of the net worth of the company at that point of time.
Incorporation LLC vs other types of incorporation
The beauty of an incorporation LLC vs other types of companies is that, in case of losses incurred by the company or when the company is being wound up, unlike for the sole trader and partnership, the personal belongings of the investor are not called upon in case where the assets of the company are fewer than its liabilities.
Types of LLC
Thus the above type of incorporation is the safest way to invest your money and is preferred all over the world. A Limited Liability Company can further be divided into two (2) categories.
*Corporation Limited by Shares
*Corporation Limited by Guarantee
Limited Liability Corporation has several characteristics which are enlisted below to give you a more detailed knowledge of LLC information:
*Owners of the LLC are called members
*Number of members in an LLC is unlimited
*Members may be individuals, corporations, or other LLCs
Advantages of a Limited Liability Company
The primary advantage of incorporation LLC is the protection given to its members at the time of bankruptcy. Other advantages are listed below:
*It is a separate legal entity from its members
*An incorporation LLCs members cannot be held personally liable
*Limited Liability Companies can adopt various forms of distribution of profit
*The LLC business structure requires no corporate minutes or resolutions and is easier to operate
*The members of LLC avoid double taxation on their income
*There is no intervening structure in a limited liability corporation.
*Limited Liability Corporations have more flexible profit distribution methods.
*There is no curtailing of investment and number of members
*The entire structure is comparatively informal, ensuring the smooth and easier running of the business
*Setting up a Limited Liability Company is simpler and quicker
*No loss of power to board of directors (BOD) based on number of members.
Forming a LLC? Be aware of the laws! The important factor to be considered when forming a L.L.C/LLC is that this is a relatively newer form of business available to you. As a result of this most of the countries have different rules and regulations for setting up LLCs.
Before setting up an LLC for yourself you should be aware of the laws applicable in the jurisdiction where it is being setup. Please seek out legal advice or advice from professional accountants.
When looking for a lawyer, ensure that he or she has knowledge of and experience in setting up a limited liability company under the particular laws of the state or country jurisdiction where you intend registering your company.
Both Stephen Nelson & Ramapati Singhania are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
Stephen Nelson has sinced written about articles on various topics from Finances, Setting Up Company and Tax Deductions. Seattle CPA Stephen Nelson specializes in serving small business entreprenuers. The author of QuickBooks for Dummies, he also publishes the do-it-yourself