Starting your own business can be a little unnerving, but also an extremely rewarding experience. The way you set your business up not only affects many aspects of your business, but it also can affect you directly—in how much personal liability you have at stake in the business, the regulations that you will need to adhere to, how your bookkeeping will be handled, and how income tax will be paid.
For these reasons, a lot of small business owners choose to form their business as a limited liability company or LLC. Here, we will cover why certain businesses should register as an LLC, how to set up bookkeeping for an LLC, and how taxes are handled with this type of business entity.
Why should certain businesses register as a limited liability company (LLC)?
An LLC includes elements that are similar to sole proprietorship, partnerships, and a corporation. An LLC, therefore, represents an ideal business model that is able to adapt to varying business conditions. In fact, it’s the most flexible business structure of them all.
Limited liability corporations allow business owners the choice to file the LLC’s income tax either as a sole owner or corporation, it provides liability protection for your personal assets from court judgements and debts, and LLCs are subject to fewer governing requirements. It’s easy to see why this business entity is a popular choice for small business owners.
How do you register your business as a limited liability company?
To establish your business as an LLC, you’ll need to register the business name with the state. Then, you’ll need to establish an operating agreement. This operating agreement basically spells out your business operations, who is affected by the business operations, and procedures to follow should you terminate the business.
Once you file this paperwork with the state, you’ll be issued a certificate of operation. The certificate of operation will include your tax id number that will be used for tax purposes and setting up a business bank account.
Should I separate my personal and business finances?
It’s extremely important to have a separate business bank account from your personal funds to keep all of your personal and business transactions completely separated. By having separate business accounts, you can have all of your business income and expense transactions in one place. This makes it much easier when calculating your business’s tax obligations, especially the small business tax deductions. Intermingling personal finances with business finances can lead to potential problems with the IRS.
Types of accounts
There are many different types of accounts that small businesses can choose from. These include separate checking accounts, savings accounts, and credit card accounts.
Small business owners should have both a business checking account and a business savings account. The checking account is used to receive customer payments and pay expenses and the savings account is used for tax obligations and unexpected business expenses.
Which accounting method should I choose?
The LLC will need to use one of two accounting methods: cash or accrual.
Cash accounting method
With the cash method, expenses are deducted when paid and cash is accounted for when it is actually received. This is a popular accounting method among small businesses due to its simplicity.
Accrual accounting method
With the accrual method, business expenses are recorded when the product or service is received and income when the sale occurs. The accrual method projects a more accurate picture of your business’s revenue and expenses.
The cash accounting method isn’t as precise as the accrual accounting method, but it does provide the opportunity of deferring taxes until you actually have the funds in hand.
Why should I use a general ledger?
The general ledger is the foundation of your accounting system. It’s a record of all of your business’s transactions. These transactions are categorized into equity, revenue, expenses, liabilities, and assets. From these categories, you can create your chart of accounts. The general ledger allows you to organize and manage all of your financial information. It’s used to apply for business loans, balance your accounts, and prepare for an audit.
Do I need to record all of my transactions?
It’s important to keep an accurate record so that all business transactions can be tracked. These include income earned, business expenses, and payable tax obligations.
Supporting documents that should be kept on hand as proof of these transactions include the following:
- Business receipts for expenses such as office supplies or travel expenses
- Bank statements
- Tax returns
- Financial statements
- Proof of payment
- Bills for office utilities, telephone, internet, etc.
How do LLCs handle their taxes?
Not only will you need to decide how to set up your LLC accounting, but also how you want to be taxed.
Single Member LLC
If you’re the only owner of the LLC, your business will be taxed as a sole proprietorship. Filing as a Single Member LLC, business profits or losses will be taxed or flow through your personal federal tax return.
For reporting your business income, you’ll attach a Schedule C to your 1040 tax form. Also, a Schedule SE will be attached for reporting self-employment taxes.
If you have multiple owners, you will be considered a partnership. Each owner pays taxes through their personal taxes based on their profit share in the company. You’ll need to attach a Schedule E to your 1040 for reporting income from partnerships.
Form 1065 needs to be filed as proof that all members of the LLC are filing their business income or losses correctly. A Schedule K-1 must also be filed that shows the breakdown of each member’s share percentage.
If an LLC wants to be treated as a corporation, you will need to file Form 8832, and you will be taxed at the corporate rate. Generally, if your personal income falls in a higher tax bracket, it may be wiser to be taxed as a corporation. Regular corporations are usually taxed at about 21%.
Multiple-owner LLCs are taxed twice if the LLC is treated as a corporation. The LLC will be taxed at around 21% and each shareholder is responsible for paying taxes on their dividends at the capital gains rate.
Frequently asked questions
In order for an LLC to run efficiently and ultimately as a successful business, it’s essential that accurate records and books are kept. Keeping books is the only way a company can establish accurate and realistic financial projections and reach any goals.
First choose the accounting method that best suits your business, create a chart of accounts, and record all of your transactions. These transactions will be categorized and then transformed into financial statements.
LLCs can choose to use either the cash method or accrual accounting. With the cash method, expenses are deducted when paid and cash is accounted for when it is actually received. With the accrual method, business expenses are recorded when the product or service is received and income when the sale occurs.
LLCs are a very popular business structure because they offer both protection and flexibility. An LLC offers the financial and legal protection of a corporation and the structural and financial flexibility of a sole proprietorship.
Caryl Ramsey has years of experience assisting in different aspects of bookkeeping, taxes, and customer service. She uses a variety of accounting software for setting up client information, reconciling accounts, coding expenses, running financial reports, and preparing tax returns. She is also experienced in setting up corporations with the State Corporation Commission and the IRS.
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