How Do Capital Accounts in LLCs Work?

by Shaa Hudson
Companies should keep an accurate record of each member's contributions.

Companies should keep an accurate record of each member's contributions.

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An LLC's capital accounts allow the company to maintain an accurate accounting of each member's contributed cash or property: They are "running totals" of the members' ownership and investment. When forming a limited liability company, each member contributes a certain amount of cash or real property to the company. Often, although not necessarily, the amount each member contributes at the beginning forms the basis for his ownership. If two LLC members each contribute $50,000 to start a business, they will typically each own 50 percent of the business. Periodically, capital accounts are adjusted up or down to reflect profits or losses to the business, in accordance with each member's ownership and the terms of the operating agreement.

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Operating Agreement

The LLC's operating agreement governs the activities of the capital accounts, such as the authority of the member keeping the accounts, which activities trigger a change in the capital accounts, and how the accounts are affected by such changes. Each contribution to the capital account is itemized in terms of a dollar amount, reflecting the amount of cash or the fair market value of real property contributed. Using our earlier example, one member might have contributed $50,000 in cash, and the other member might have contributed property for which the fair market value is $50,000. Both would have $50,000 recorded in the capital accounts.

Capital Account Allocations

Each member of a limited liability company has his or her own capital account. Periodically, when the company incurs profits or losses, the member's capital account increases or decreases proportionally. For example, if the company saw a profit of $10,000, each of the 50 percent owners in the earlier example would see $5,000 added to each capital account: The owners would now each own $55,000 worth of the business. The following year, if the business lost $12,000, each owner would see his capital account decreased by $6,000: They would have $49,000 each invested in the company. Any taxes, discrepancies, or changes in the capital structure of the company will affect a member's capital account. Such changes are usually agreed upon by each member in the company's operating agreement, the governing document. As long as the operating agreement doesn't conflict with state laws, LLC members may make any arrangements they like. For example, two $50,000 owners might agree to distribute profits and losses differently from a 50-50 split, but the operating agreement must state what the arrangement is.

Creating an Account

Because a capital account is simply a running total of members' ownership in the company, it can be created very simply. A company may create a capital account with a spreadsheet, accounting software, or other accounting system. The bookkeeper or accountant of the company creates a capital account by keeping a log of financial activities for each member.

Maintenance

Maintaining capital accounts for each individual member is the simplest way for a company to remain organized. Although the terms of the operating agreement must be followed, they are not set in stone. It is often possible to renegotiate the terms of the operating agreement in order to change a member's percent of ownership in the company, or the amount he receives in allocations. Operating agreements will usually outline the way in which members can make such changes.