Paying the Owners of a Limited Liability Company

A tricky question that new limited liability company bookkeepers often have concerns how to record correctly the payments made to the owners. Are the payments wages, for example? Partnership draws? Or something else entirely different?



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. In that case, amounts paid to the limited liability company member should be accounted for 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 an LLC owner for working in the business 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 get treated in a manner similar to owner draws or partner draws in your accounting software.





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Seattle CPA Stephen L. Nelson specializes in serving small businesses and their owners. The author of QuickBooks for Dummies, he also publishes the do-it-yourself

S corporation

and limited liability company web sites.

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