What is Capital Account?

In a partnership or multi-member LLC, each owner has a capital account showing their share of the business's equity. It is the partnership equivalent of owner's equity for a single owner.

What changes a capital account

Increases:

• Cash or property contributed by the partner
• The partner's share of partnership income

Decreases:

• Distributions to the partner
• The partner's share of losses and certain deductions

Example

A partner contributes $20,000, is allocated $35,000 of profit and takes $25,000 of distributions in the year. The capital account increases from $20,000 to $30,000.

Reporting

Partnership returns report each partner's capital account on Schedule K-1. Current IRS instructions require capital accounts to be reported on the tax basis method. The partnership agreement may also require capital accounts maintained under other rules for allocating profits and liquidating distributions. See Form 1065 and IRS Publication 541.

Capital account vs basis

A partner's capital account is related to, but not the same as, their outside tax basis, which also includes the partner's share of partnership liabilities. Basis determines whether losses are deductible and distributions taxable.

Why it matters

Capital accounts determine what each partner would receive on liquidation and are central to disputes when partners leave. Keeping them up to date in the books, with a rollforward each year, prevents arguments and preparer time.

In the books

Use separate equity accounts per partner for contributions, distributions and allocated income. Record guaranteed payments as expenses, not capital changes.

Related terms

• Liabilities: Liabilities are amounts a business owes to others, such as suppliers, lenders, employees and tax authorities.
• Owner's Equity: Owner's equity is the owners' stake in the business: assets minus liabilities.
• Tax Basis: Tax basis is the amount the tax law treats as your investment in property, used to figure depreciation and gain or loss.
• Schedule K-1: Schedule K-1 reports each owner's share of a partnership's or S corporation's income, deductions and credits.

Browse more definitions in the small business glossary.