When forming or operating a Limited Liability Company (LLC), it’s important to understand how ownership, contributions, and profits are tracked. One key concept that plays a central role in this process is the “capital account.”
So, what is a capital account in an LLC — and why does it matter?
In this article, we’ll explain:
- What a capital account is
- How it works in a multi-member vs. single-member LLC
- What’s recorded in the capital account
- Why it matters for distributions, taxes, and business growth
What Is a Capital Account?
A capital account in an LLC is an individual accounting record that tracks each member’s:
- Initial capital contributions (cash, property, services, etc.)
- Additional contributions over time
- Share of profits and losses
- Distributions (withdrawals of money or assets)
Each LLC member has their own capital account. It represents their equity or ownership stake in the company.
Example:
Jane and Mark form an LLC. Jane contributes $50,000 in cash, and Mark contributes $25,000 and property worth $25,000. Their initial capital accounts are:
- Jane: $50,000
- Mark: $50,000
Over time, if the LLC earns profits or distributes funds, those changes are reflected in each member’s capital account.
What Is Recorded in a Capital Account?
1. Initial Contributions
Money, equipment, inventory, or property contributed to start the business.
2. Additional Contributions
Any future investment by a member increases their capital account.
3. Allocated Profits or Losses
Profits increase the account; losses decrease it — based on the ownership percentage or operating agreement.
4. Distributions
Money or property taken out by the member reduces their capital account balance.
Capital Account Formula:
Capital Account Balance =
Initial Contribution
- Additional Contributions
- Allocated Profits
– Allocated Losses
– Distributions
Single-Member vs. Multi-Member LLCs
Single-Member LLC:
There’s only one capital account, which tracks all contributions and distributions of the sole owner.
Multi-Member LLC:
Each member has a separate capital account, typically managed in accordance with the LLC Operating Agreement.
Why Capital Accounts Matter
1. Ownership Clarity
Capital accounts show how much each member has invested and what they’re entitled to in return.
2. Profit Distributions
Distributions are often made in proportion to the capital accounts (unless stated otherwise in the Operating Agreement).
3. Tax Reporting
Capital accounts are reported on IRS Form 1065 (for multi-member LLCs) and Schedule K-1. The IRS uses this to track each member’s share of income and basis in the business.
4. Exit or Buyout
If a member exits or sells their interest, the capital account helps determine their buyout value.
IRS and Tax Basis
Capital accounts are often confused with “tax basis.” While they’re similar, they’re not always the same.
- Capital Account: Based on book (accounting) values
- Tax Basis: Reflects tax-deductible items and tax laws (e.g., depreciation, liabilities assumed)
You’ll want to work with a CPA to reconcile both for accurate reporting.
Common Mistakes to Avoid
- Not maintaining accurate capital accounts
- Failing to record non-cash contributions properly
- Making distributions that exceed a member’s capital account
- Not updating accounts after each tax year
Final Thoughts
Capital accounts are a vital part of managing an LLC — whether you’re a solo entrepreneur or working with partners. They help track ownership, measure investment, and ensure legal and tax compliance.
If you’re forming an LLC, make sure your operating agreement clearly defines how capital accounts are handled, including how profits and losses are allocated.
At FormLLC, we help new and existing businesses form compliant LLCs with custom operating agreements, EIN registration, and bookkeeping guidance — including how to manage capital accounts correctly.
