Capital Accounts in Illinois LLCs
Illinois limited liability companies have the option to be taxed like a sole proprietorship/partnership or like a corporation. LLCs that elect to be taxed as a partnership require a separate capital account for each member. A capital account is also sometimes referred to as an equity account. Capital accounts allow a business to maintain an accurate accounting of each member's contributions to the business or, in other words, provide "running totals" of the members' ownership and investment.
Capital account balances are used to determine how distributions are made to the members during the course of business or in the event of a liquidation or sale. Capital accounts are not static over the life of a company and are frequently adjusted up or down to reflect the business’s profits or losses, in accordance with each member's ownership and the terms of the operating agreement. Typical ways of increasing a capital account include:
- A member’s initial investment to the LLC
- Additional contributions to the LLC
- A member’s share of the business’s profits
Conversely, capital accounts are typically decreased by:
- A member’s share of the business’s losses
- Withdrawals for personal use
Capital accounts that are positive reflect positive equity in the company while capital accounts that are negative reflect debt owed to the company. Determining the proper amount of each member’s capital account is a common source of dispute in business divorce litigation.
Members of an LLC often do not pay too much attention to their respective capital accounts until a dispute arises between the members and one member wishes to dissociate from the LLC or the members agree to sell the business. In any of these events, the members should look to the operating agreement for guidance on how capital accounts affect what each member will receive.
The provision of capital accounts is generally laid out in the LLC’s operating agreement. The operating agreement may detail precisely what each member will contribute to the business and how much will be credited to the member’s capital account for such contributions. For instance, one member may contribute money to the business while another member contributes land or a building. Another member may contribute his or her labor to the new business—sometimes referred to as sweat equity. Each member will receive a corresponding credit to his or her capital account for these contributions. Accordingly, the operating agreement should memorialize these contributions as well as the amount to be credited to each member’s capital account. The operating agreement should also include procedures for valuing later non-cash contributions to the business.
Ideally, LLCs would apply basic accounting principles (e.g. Generally Accepted Accounting Principles (“GAAP”) or Other Comprehensive Basis of Accounting (“OCBOA”)) to represent member’s capital account balances and fluctuations to those accounts. When companies do not adhere to accepted accounting principles, it is often necessary to engage forensic accountants as expert witnesses to review the financials of a business to determine how capital account balances were calculated and to opine as to what the value of the capital account balances should have been if proper accounting principles had been followed. As one can imagine, this can become quite expensive so it is best to always keep accurate records that scrupulously account for each deposit and withdrawal to a member’s capital account in accordance with a well-accepted accounting method.
If you suspect that a member is not accurately keeping the accounts or is deviating from accepted accounting principles in calculating changes to the capital accounts, it is advisable to retain the services of a business dispute attorney. The attorney will advise you of your rights to examine the business’s books and can assist in retaining the necessary professionals to determine if there are discrepancies in the capital accounts.
LLC member dispute law is always changing and evolving. LLC dispute and business divorce attorneys must have extensive knowledge of shareholder, LLC, and partnership law, to defend or advance the rights of their clients. The LLC lawyers at Lubin Austermuehle have more than thirty years of experience defending and prosecuting claims involving LLC members including breach of fiduciary duty and fraud claims and claims involving the freeze-out of members in the federal and state courts in Illinois.
Super Lawyers named Illinois commercial law trial attorney, Peter Lubin, a Super Lawyer and Illinois business dispute attorney, Patrick Austermuehle, a Rising Star in the Categories of Business Litigation, Consumer Rights Litigation, and Class Action Litigation. We are knowledgeable in the areas of LLC dispute and capital account fraud law. We are committed to fighting for our clients' rights in LLC dispute cases at both the trial and appellate court levels. We have successfully defended or prosecuted LLC cases achieving large settlements for our clients or winning them control of their business.
Conveniently located in Chicago and Elmhurst, Illinois, we have successfully litigated business separation, accounting and breach of fiduciary duty cases for clients all over the Chicago area. To schedule a consultation with one of our skilled attorneys, you can contact us online or give us a call at 630-333-0333.