Limited liability companies (LLCs) are popular business structures for gym owners of all shapes and sizes. LLCs provide the benefits of limited liability and flexibility in management and taxation. One important aspect of LLCs is capital accounts, which are used to track the financial contributions and distributions of the members.
What are Capital Accounts?
Capital accounts are individual accounts that track the financial contributions of LLC members. These include their initial investment, additional capital contributions, and their share of the profits or losses.
Capital accounts are important because they determine the allocation of profits and losses among the members of an LLC. The ownership percentage for each member determines the allocation. The initial capital account balance determines the percentage of ownership. As such, members with larger capital account balances generally receive a larger share of the profits or losses.
LLC Members make initial investments to fund the company’s operations. These investments are known as Capital Contributions. This can be in the form of cash, property, or services. The member in charge of accounting records the capital contribution in the capital account of each member.
LLC members then receive distributions from the company. This simply means that the members agree to take profits out of the business. This is how members of a LLC typically get paid. These distributions are not considered taxable income and are not deductible by the LLC.
Generally speaking, the LLC makes distributions based on the members’ ownership percentage. The capital account balance may also determine the size of the distribution. Members with larger capital account balances may receive a larger share of the distributions. Therefore, it is incredibly important for members to determine percentage ownership in the beginning. The partners then record this ownership percentage in the Operating Agreement.
Profits and Losses
LLCs can be taxed as pass-through entities. This means that the profits and losses of the company are passed through to the members and reported on their personal tax returns. Each members’ ownership percentage determines the allocation of profits and losses.
For example, if an LLC has three members with equal ownership, each member would have a capital account balance of one-third. If the company earns a profit of $30,000, each member would be allocated $10,000 of the profit based on their capital account balance. The same would apply to losses.
Complicated, but Important
While seemingly complicated, capital accounts are important for LLCs because they track the financial contributions of the members. The initial contribution determines the ownership percentage and the allocation of profits and losses. LLC members should understand how capital accounts work to ensure that they are being treated fairly. Issues regarding money are the #1 cause of problems in partnership. If you have questions or concerns about capital accounts in your LLC, please reach out. This can be a complicated topic.