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How Changing Your Business to an LLC Affects Your Bookkeeping

  • Apr 15, 2015 | Ryan O'Donnell

If you're a sole proprietor who's considering forming an LLC, it's important to know how it can affect your bookkeeping. While your requirements for concerns like sales and income tax will likely remain unchanged, transferring to an LLC does present an opportunity to reevaluate your tax year and bookkeeping procedures. Here are a few key points to keep in mind.

Choosing an Accounting Method

If you're like most small business owners, you're considering forming an LLC because your business has been successful, and you're looking to move into the next phase of growth. Accordingly, this is a good time to decide you should change your accounting method.

There are two primary accounting methods: cash accounting and accrual accounting. In cash accounting, you list your revenue and expenses on the date that you receive or spend the funds. So, if you complete a job for a client in September but don't receive payment until late October, you won't record that revenue until it arrives in late October.

In accrual accounting, you record revenue and expenses on the date a sale was made (for revenue) or when services or goods were received (for expenses.) Using the previous example, you would record the income for the client's job in September, when the job was completed, even if you won't receive the actual payment for it until October.

Pros and Cons of Each Method

Most sole proprietors use cash accounting because it's the simplest method to use and provides the most accurate picture of your cash flow at any given moment. On the other hand, cash accounting may not be a good representation of your overall profit and loss situation, especially if your business is growing as an LLC.

If you've taken on investors after forming an LLC, switching to an accrual accounting method can be a better choice when you have to issue profit and loss reports. As an example, consider a situation in which you have completed several large projects in 2015 but won't be paid for them until 2016. If you're issuing a report to your investors using the cash method, it will seem as if you had no income for 2015 and are struggling as a business. Making a report using the accrual method allows you to most accurately represent your business activity for the year.

Accounting Method Impact on Sales Tax

While your chosen accounting method won't change your obligation for collecting and remitting sales taxes, it can affect the timetable for how you report the same. This can be especially relevant if you're entitled to business income tax deductions or other tax discounts based on how much sales tax you paid to the applicable state.

Choosing a Tax Year

As a sole proprietor, your tax year is determined by your personal income taxes, so it's set from Jan. 1 to Dec. 31 automatically. The IRS does allow you to petition for a different tax year but is more likely to accept that change if you have formed an LLC.

So, instead of using the standard personal tax year, you may want to switch to a fiscal year arrangement, which lets you set your own terms for the taxable year. This can be a good idea if your business operates seasonally. For example, if a significant portion of your income and expenses happens during the winter months, switching to a fiscal year from June 1 to May 31 avoids a tax year that "splits" your most active business months between two separate years.

It's important to note that while the IRS is more likely to grant a petition for a tax year change as an LLC, once your tax year has been changed, you won't be allowed to change it again for 10 years.

Sales tax rates, rules, and regulations change frequently. Although we hope you'll find this information helpful, this blog is for informational purposes only and does not provide legal or tax advice.
Avalara Author
Ryan O'Donnell
Avalara Author Ryan O'Donnell