A common question that new limited liability company owners have is "How do I account for money that I take out of the business?" And this question can be tricky to answer. Are the payments wages? Dividends? Draws on LLC profits? Or something else?

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.

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