New LLC Bookkeeping Setup Checklist: What to Decide First

What does a new LLC decide before its first entry in the books?

A new LLC settles eight things before it records a transaction: how the IRS taxes it, its tax year, its accounting method, its EIN and bank account, whether it needs a sales tax permit, how it pays workers, how it records costs the owner already paid, and who keeps the books. These choices are linked, and several need the EIN, so apply for it right after the state forms the LLC.

A case stops being simple when the LLC has two or more members, may elect S corporation status, sells taxable goods in more than one state, will hire, or already has months of transactions in a personal account. After the first return, changing the accounting method generally needs IRS approval, and changing the tax year may (Publication 538; Publication 583).

Gather first: the state's formation papers, the operating agreement, the EIN confirmation letter, bank account details and any state registration numbers. Decide who will keep the books and in what tool (software, a spreadsheet or a bookkeeper); see doing your own books or hiring a bookkeeper and bookkeeping in a spreadsheet. A chart of accounts that maps to the tax return comes after these decisions; see chart of accounts for Schedule C. Filings due after formation are in what to file after you form your company.

What bookkeeping does a single-member LLC need compared with a multi-member LLC?

A single-member LLC keeps the books a sole proprietor would: income, expenses, the owner's investment and the owner's draws, with a business account and a document behind every entry. A multi-member LLC adds a capital account for each member. An LLC taxed as a corporation adds payroll for owners who work in it.

The federal tax classification, not the LLC label, decides which applies. A domestic LLC with one member is part of its owner's return, and one with two or more members is a partnership, unless it files Form 8832 to be taxed as a corporation (IRS; Form 8832). Membership changes the class: a one-member LLC that adds a member becomes a partnership, and a partnership left with one member becomes disregarded (26 CFR 301.7701-3(f)(2)). How LLCs are taxed covers the choice itself.

A capital account is a running record of what a member put in, earned and took out. Entries for each owner account are in LLC equity accounts.

An S election is made on Form 2553, with a consent from every owner. The ordinary deadline is 2 months and 15 days after the start of the tax year the election is to take effect; a new LLC counts from the earliest day it had owners, assets or business. A late election generally takes effect the next year unless relief is granted, which needs reasonable cause and a request within 3 years and 75 days of the intended date (Form 2553 instructions). Only an entity that meets the S corporation tests can elect, for example no nonresident alien shareholders and one class of stock. A timely election treats the LLC as a corporation from the effective date without a separate Form 8832, and the books change on that date: an S corporation must pay a shareholder who works in the business reasonable pay as wages before it makes other distributions (IRS). See should you elect S corporation status for eligibility and timing, late S corporation election relief for a missed deadline and books after an S corporation election.

Spouses who own an LLC outside a community property state should generally file as a partnership. In a community property state, the IRS accepts either partnership or disregarded treatment for an LLC the spouses wholly own as community property (IRS). See spouse and family LLCs.

Should a new LLC use a calendar year or a fiscal year?

The calendar year is the most common tax year (Publication 538). A single-member LLC follows its owner's year; partnerships and S corporations have less freedom.

Unless it has a required year, an LLC adopts a year by filing its first return on it. Getting an EIN, filing an extension or paying estimated tax does not adopt one (Publication 538).

A partnership or corporation formed mid-year files a first return that covers only the time it existed (Publication 538). How to find or change a year-end is in fiscal year or calendar year.

Cash or accrual: which method should a new LLC start with?

Most individuals and many small businesses use the cash method (Publication 538), and a new LLC can start on it unless one of the three limits below applies. Under cash, income counts when received and expenses when paid; under accrual, income counts when earned and expenses when incurred (Publication 583). A new LLC may choose any permitted method on its first return without IRS approval (Publication 538), and Publication 583 says to use the same method to figure taxable income and to keep the books (Publication 583).

Three things can take the cash method away:

• Corporation status. A C corporation, including an LLC that elects to be one, and a partnership with a C corporation partner generally cannot use cash unless it meets the gross receipts test (average annual gross receipts for the 3 prior tax years at or below $32,000,000) or is a qualified personal service corporation (substantially all of its activities in health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting, and substantially all of its stock owned by the employees who perform them, retirees, their estates, or heirs for 2 years after a death). Related businesses treated as a single employer count together; a business that has existed less than three years uses the years it has, annualizes any short year and counts a predecessor's receipts (26 U.S.C. 448; Publication 538). An S corporation is not in this group.
• Tax shelter status. A tax shelter, a term the statute defines, cannot use cash at any size; the gross receipts exception does not reach it. The term includes a syndicate: an entity other than a C corporation that allocates more than 35% of its losses to limited partners or limited entrepreneurs, owners who generally do not actively manage it (26 U.S.C. 448; 26 CFR 1.448-2).
• Inventory. When buying and selling merchandise is part of earning income, purchases and sales are accounted for on accrual. A small business taxpayer (receipts at or below the same limit, and not a tax shelter) may choose not to keep an inventory, but must still use an inventory method that clearly reflects income (Publication 538).

After the first return, switching between cash and accrual generally needs IRS approval on Form 3115 (Publication 538). If a lender, investor or landlord will want statements on the other basis, decide before the first return: accrual statements beside a cash return need records that reconcile them to the return (26 CFR 1.446-1(a)(4); Schedule M-3 instructions, line 14). See accrual books and a cash-basis tax return and cash or accrual for a small business.

Does the LLC need an EIN yet, and when does a single-member LLC need one?

Most new LLCs do, as the table shows. Apply right after the state forms the LLC, because banks ask for the EIN and the IRS says an application may be delayed otherwise. EINs are free, and the IRS warns against websites that charge for one. The online tool needs a US principal place of business and a responsible party with an SSN or ITIN; an LLC that cannot use it applies by phone, fax or mail (IRS).

Apply early enough to hold the number by the time a return is due or a deposit is made (Publication 583).

One trap: when a customer asks a one-member LLC for a Form W-9, the IRS says a disregarded LLC owned by an individual gives the owner's SSN or EIN, not the LLC's EIN (IRS). If the owner is a foreign person, the owner gives the appropriate Form W-8 instead, even with a US taxpayer ID. An LLC classified as a corporation or partnership gives its own EIN (Form W-9 instructions).

Does a new LLC need a separate bank account and card from day one?

The IRS tells new business owners to open a business checking account early and keep it separate from the personal one. The business checkbook is the basic source for recording business expenses, so a mixed account means every entry needs sorting later (Publication 583).

Banks commonly ask for the EIN, formation documents and the ownership agreement, and keeping business and personal funds apart supports limited personal liability protection (SBA). Whether and when to open one is in business bank account for an LLC.

From the first deposit:

• Deposit all receipts into the business account, and label each deposit as business income, personal funds or a loan (Publication 583).
• Pay business costs from the business account or card, and personal costs from personal money. A personal withdrawal is not a business expense; which owner account it hits depends on how the LLC is taxed (see LLC equity accounts).
• Reconcile the account to the books every month (Publication 583).

Personal and business money already mixed is covered in fixing mixed business and personal funds.

Does the LLC need a sales tax permit, and what does it add to the books?

Only if the state's registration rules reach it: what the LLC sells, its connection to the state and any exception, such as a marketplace that collects the tax for it. Each state decides, so check your state's tax agency before the first sale. California is one example: a seller must hold a California seller's permit if it is engaged in business there and intends to sell or lease tangible personal property that would ordinarily be subject to sales tax at retail. The rule covers LLCs, the permit is free, and it is separate from a local business license (CDTFA Publication 73). A seller whose retail merchandise sales are all made through a marketplace facilitator registered with CDTFA need not register; any direct sale can change that (CDTFA). Where an LLC must collect when it sells into other states is in when you must collect sales tax.

A permit changes what the books track. At minimum there is a sales tax payable account, because tax collected is owed to the state and is not income (Publication 583). A state's own rules add details. California, for example, requires a sale to be reported for the period it happens even if paid later, requires returns for periods with no sales, and requires the seller to keep resale certificates from customers who buy without tax. It also says responsible individuals may be personally liable for tax a corporation or LLC owes (CDTFA Publication 73). Other states differ. Entries are in sales tax journal entries.

What should the LLC set up for employees and contractors?

An LLC with employees sets up payroll before the first paycheck, and an LLC that pays contractors collects a Form W-9 from each US contractor before the first payment. Owners are not on payroll by default.

A one-member LLC is still a separate entity for employment tax, so it reports wages under its own name and EIN (IRS). Most employers pay a state unemployment tax as well as the federal one (Publication 15). Wrongly treating an employee as a contractor can make the LLC liable for employment taxes plus a penalty (Publication 583). Tax withheld from pay is held in trust: a responsible person who willfully fails to pay it over, such as an officer, a partner or anyone with authority to spend the business's money, owes a trust fund recovery penalty equal to the unpaid tax, and the IRS generally has 3 years to assess it (Publication 15; 26 U.S.C. 6672). A contractor outside the US does not use a W-9 (Form W-9 instructions); see paying contractors abroad. Without a correct taxpayer ID, a payer generally must withhold 24% of reportable payments as backup withholding, whether the LLC is paying a contractor or being paid by a customer (IRS). Form-by-form set-up is in setting up payroll; contractor reporting is in which contractors get a tax form.

Owners. A sole proprietor is not an employee of the business (Publication 334). Payments to partners are exempt from income tax withholding, Social Security and Medicare tax, and federal unemployment tax, while corporate officers who work in the business are employees (Publication 15). Members of an LLC filing a partnership return generally pay self-employment tax on their share of earnings instead (IRS). Owner payroll therefore generally starts only after an S or corporation election.

How do I record costs I paid personally before the LLC had an account?

Record each cost at its original date and amount, with the owner as the source of the money. Money an owner puts in for the LLC is the owner's investment, or a loan if the owner and LLC agree it will be repaid as one; it is not income to the LLC. The IRS says records should identify the source of receipts so business and nonbusiness money, and taxable and nontaxable income, stay apart (Publication 583).

1. List each cost with its date, payee, amount and purpose, and keep the receipt.
2. Record the cost and the matching owner contribution (or loan) on the date paid.
3. When the LLC pays the owner back, clear what it owes first: a loan repayment or a documented reimbursement is not a draw. Paying back contributed equity is a draw for a one-member LLC and a distribution for a partnership or corporation, and a corporate distribution can be a taxable dividend (26 U.S.C. 301(c)). A multi-member LLC's payback has its own limits. Paying the owner back is not itself an expense.

Whether the cost itself is deductible now, capitalized or amortized is a separate tax question: the same publication treats most costs before operations begin as capital expenses with limited elections. See startup costs paid personally before the LLC, which also covers a multi-member LLC's payback.

What records should the LLC keep from the first day?

Except in a few cases, the law does not require a special kind of records, but the system must clearly show income and expenses, and supporting documents must back every entry (IRS; Publication 583).

How long to keep each record is in how long to keep business records; missing receipts are in lost receipts for business expenses.

Example

These examples are illustrative. All figures are in US dollars.

A designer's one-member LLC, formed October 1

The LLC files with the state on October 1, receives its EIN and opens a checking account with the EIN and formation papers. Its books start October 1 on the owner's calendar year and the cash method. Before the account existed, the owner paid $2,000 of formation costs on a personal card. The books record $2,000 of costs and $2,000 of owner's investment, dated when paid. On November 5 the LLC repays the owner $2,000, recorded as an owner draw, not an expense. Whether the costs are deductible is a separate question.

A two-member product LLC with sales tax

Two friends, both individuals who work in the business, form an LLC that resells goods. It is a partnership by default, so it will file Form 1065 and keeps a capital account for each partner; each partner puts in $25,000 in cash, so each account opens at $25,000. The LLC obtains its state permit. With no C corporation partner and no passive investors, and receipts far under the gross receipts limit, it may use the cash method and, as a small business taxpayer, choose not to keep an inventory, though it must still use an inventory method that clearly reflects income. It sells $150,000 of taxable goods, before tax, in its home state. At an illustrative 6% rate, customers pay $9,000 of sales tax, which sits in a sales tax payable account until filed and is not income.

An LLC planning an S election and one employee

A one-member consulting LLC, owned by a US citizen, plans an S election effective the next January 1 and hires a part-time employee in November at $2,000 a month. Before the first paycheck it sets up wages expense, payroll tax expense and payroll liability accounts, collects the employee's Form I-9 and Form W-4, and runs payroll under the LLC's own EIN. It files Form 2553 no later than March 15, the deadline for a January 1 effective date; filed later, the election generally takes effect a year later unless relief is granted. Until December 31 the owner takes draws. From January 1 the owner is also on payroll at reasonable pay, any further owner payments are distributions, and the equity accounts change from draws to distributions on that date.

Different for you?

• The LLC has two or more members, or may add one: each member needs a capital account that matches the operating agreement, and costs a member paid personally run through that account. A one-member LLC that adds a member becomes a partnership on that date. See partner capital accounts, LLC equity accounts and splitting ownership between LLC partners, and bookkeeping help if the books must match the first partnership return.
• You plan an S election: the books and payroll change on the effective date, and a late election needs relief. See should you elect S corporation status and books after an S corporation election, and bookkeeping help if payroll and owner accounts must change on the effective date.
• You sell in more than one state: each state can require its own permit and returns. See when you must collect sales tax, tracking sales by state and registering in another state, and bookkeeping help if sales tax accounts must tie to several states' returns.
• You will have employees: see setting up payroll, and bookkeeping help if payroll accounts must tie to the first quarterly return.
• Months of transactions already sit in a personal account: the books need repair before the first return. See fixing mixed business and personal funds and catching up on overdue books, and bookkeeping help if the repair is more than you can sort alone.
• An owner lives outside the US: the EIN application may have to go by phone, fax or mail, and an S election is closed to nonresident alien shareholders. A US LLC wholly owned by one foreign person files a pro forma Form 1120 with Form 5472 for any year with a reportable transaction, and the penalty for failing to file or keep the records is $25,000 (Form 5472 instructions). See forming and running a company from abroad, bookkeeping for a foreign-owned US company and foreign-owned single-member LLC filing, and bookkeeping help if the books must be set up around an owner abroad.
• You are deciding whether to keep the books yourself: see doing your own books or hiring a bookkeeper, and bookkeeping help if the books must follow a partnership or S corporation return from the first month.