Capital Accounts LLC: Everything You Need to Know
Capital accounts LLC are individual accounts of each person's investment in an LLC.5 min read
Capital accounts LLC are individual accounts of each person's investment in an LLC. These accounts track the contributions of the initial members to the LLC's capital, and adjustments are made for additional contributions.
Ways to increase the balance of a capital account include:
- Initial investment.
- Additional contributions.
- Share of profits.
Ways to decrease the capital account balance include:
- Share of losses by members.
- Withdrawals for personal use.
When an LLC is dissolved, capital accounts go back to the individual members after any liability payments of the LLC are made. This payment distribution to members is made in order of priority. Capital accounts are not the same as bank accounts. Members don't have to have a bank account separate from the LLC capital account.
How Do Capital Accounts Work?
A lot of business owners like LLCs because these types of businesses offer limited liability for the owners. Individual members in the LLC have capital accounts, and each person should have a full understanding of the account basics. A person's ownership is formed on the basis of the amount he or she contributes at the beginning. "Running totals" are kept on the ownership and investment of members.
Sometimes, adjustments are made to capital accounts, either up or down. These adjustments reflect business profits or business losses according to the ownership of each member as well as the operating agreement terms.
Creating a Capital Account
Your business can create this type of account with:
- Accounting software
- A spreadsheet
- Another accounting system
The company's accountant or bookkeeper creates a capital account and maintains a log of each member's financial activities.
Capital Account Maintenance
The easiest way for a business to stay organized is to maintain capital accounts for individual members. Sometimes, you can renegotiate the operating agreement terms to make changes to how much ownership a member has in the LLC as well as the amount of allocations that members are due.
Each member's account can be affected by:
- Changes in a company's capital structure
The company's governing document usually contains an agreement that each member adheres to when dealing with these changes. While members of the company can make arrangements, the operating agreement has to clearly lay out what the arrangement is.
Initial Balance in Capital Accounts
The initial investment of each member is his or her beginning balance. Each member owns a percentage relative to:
- Cash contributions
When profits or gains are recorded in company books, the amounts increase in capital accounts. How non-monetary contributions are valued depends on the terms of the operating agreement.
If a member contributes property, other members should come to an agreement on the property's fair market value so that the contributor receives proper credit. Capital contributions may also include assumed liabilities and services. The value of services doesn't count as a credit to an individual's capital account because their value may be taxable income to that member.
How Much Should Members Contribute to Capital Accounts?
The amount each member contributes should cover initial expenses of the LLC until the company's earnings are enough to cover the business's ongoing expenses. In the event more contributions are required, credits to members' capital accounts should reflect those additional contributions. If a company doesn't have adequate capital, the LLC could be disregarded, and members may be held personally liable for the company's debts and obligations. For LLCs with large risks or liabilities, larger capital contributions may be necessary.
Income/Loss or Distributions
Some companies are set up to calculate the percentages of the individuals' capital accounts based on amounts of:
Normally, capital account percentages are kept separate from income/loss allocations and distributions based on terms of the company's operating agreement.
Keeping Track of Capital Accounts
Businesses are taxed like a partnership by the IRS. A capital account can keep track of each member's investment in the company. The capital account is a way to measure what individuals receive if the company is sold.
The account represents:
- Combined initial investments from members.
- Additional contributions to the business from members.
- Members' share of profits and losses.
- Money or distribution of property received from the company.
When keeping track of capital accounts, you'll need to follow basic steps. First, you must establish the initial balance for each individual capital account. This amount should be the same as the market value of anything the member contributed to the company.
Second, you'll need to make sure that the member's share of the profits and losses of the LLC are adjusted each year. The handling of this step should be covered in the LLC's operating agreement.
Any time the LLC gives cash to any of its members, the amount given in cash must be subtracted from the capital account balance. Also, if any members contribute more money to the LLC after becoming owners, this should be reflected in the account. Basically, the capital account balances for members should always match their total contributions to the company, minus any amounts the company has contributed to them.
Profits and Losses
Profits and losses don't just affect the business, but they also affect capital accounts. Basically, if a member has shares in the LLC, those shares will decrease with losses and increase with profits. The specifics of such shares should be laid out clearly in the operating agreement.
Anytime an LLC is dissolved, the state requires the LLC to pay off all of its creditors before any money is distributed to members. Final distributions are the amounts paid to all members upon the dissolution of an LLC. Any money left once all of the company's credits are covered can be handed out to the members.
Final distributions, or liquidating distributions, must be handled according to the stipulations of the operating agreement. If the agreement doesn't cover the subject of liquidating distributions, the state has provisions in place to govern the process.
Decreases to Member Capital Accounts
Keep in mind that even deductible losses and expenses will decrease capital accounts. Because company creditors must be paid before final distributions are made, members must realize that they might receive less than what they originally contributed to the company if the company dissolves. This is a good incentive to stay on top of company debts.
Can You Have Negative Balances in Capital Accounts?
Some capital account balances are continuously fluctuating. Different business actions have varying effects on their members' capital account balances. Sometimes, these balances can be negative. If the LLC's losses plus expenses add up to more than the balances of the capital accounts, those accounts will likely be in the negative.
Certain operating agreements actually require the LLC members to keep their capital accounts positive. This could cause members to have to add to their accounts out of their own pockets to bring a negative balance up to zero. Such additions are viewed as member contributions, so they won't go undocumented.
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