Kim Porter | Published Nov 10, 2025 8 Min
NOTE: This post is relevant to disregarded entities, partnerships, and S corps. It is not applicable to C corp owners.
When you open a business, you and any business partners might chip in money or other assets to get things started. You’ll track how much each partner contributes using a capital account. Throughout the lifecycle of your business, the capital accounts show each partner’s monetary interest in the company.
Just so we’re all 100% clear: we’re talking about capital accounts as it relates to bookkeeping and accounting—not tax basis capital accounts. Here’s a closer look at how capital accounts work.
What is a capital account?
When you hear the term “capital account,” you might think of a business checking or savings account—but they’re not something you open at the local bank. Capital accounts are written records of each business partner’s financial stake in the company.
This is important for your business bookkeeping, of course, and it could also make a difference if you need to borrow money from a bank. The bank will want to see your capital accounts, which show owner equity. When an owner invests in a business, there’s less of a chance that they will walk away when things get tough. Banks may use information found in your capital account records when deciding if they’ll approve your business loan request and even whether or not they’ll give you a reduced loan rate.
Capital account balances change over time. As the company grows, each account grows according to the proportion of the partner’s initial capital investment. The balances can also shrink. When the business dissolves, capital accounts show how much money each partner should receive.
The structure of the capital account depends on the type of business you have:
- Sole proprietors: There’s only one business owner in a sole proprietorship, so the owner’s capital account will include 100% of the business’s contributions, distributions, profits and losses.
- Partnerships (LLCs, LPs, GPs): Each partner who invests in the company will have a capital account made up of their contributions and distributions, and the partnership agreement should spell out each member’s share of profits and losses.
- S corporations: The capital account for an S corporation shareholder reflects their share of contributions, distributions, profits and losses, for their current basis in the company. You’ll need to divide the corporation’s net income in proportion to its shares of ownership, similar to a partnership or LLC.
Capital account rules
In the early stages of setting up your small business, you’ll create governing documents. Depending on the setup of your business, these documents may include a partnership agreement, LLC operating agreement, or S corp bylaws. Within these documents, you’ll need to decide how much owners can withdraw from a capital account and when they can take it, and how you’ll handle capital transfers.
Sole proprietorships and single-member LLCs typically don’t create these guiding documents, so they can choose to make and take out capital contributions any time.
How do capital accounts change over time?
When it comes to bookkeeping, your company might decide to create separate capital accounts for each partner or combine all partners into one account. Either way, the accounts are usually recorded on the balance sheet as “equity accounts” and capture increases and decreases over time. “Equity” here is another word for ownership.
Below are some ways the balance could change, but keep in mind that there can be accounting complexities and fine print, so you’ll definitely want to discuss your situation with your accountant.
- Owner contributions: The value of a capital account increases when an owner makes contributions. For example, an owner might invest money or contribute other types of assets when the business opens. The owner may also make regular contributions throughout the life of the business.
- Business losses: When the business loses money, each capital account is reduced according to the business’s governing documents.
- Business income: As the business earns money and receives cash inflows, each capital account is increased proportionally.
- Owner distributions: Owners might be able to withdraw money from the capital pool for personal use. You’ll subtract from an owner’s capital account when they take distributions.
- Annual reconciliation: At the end of your business’s fiscal year, your bookkeeper should add or subtract from the capital account to reflect the owner’s share of the net profit or loss.
Each capital account should track the partner’s:
- Cash contributions or the fair market value of non-financial assets—like real estate property, vehicles, and equipment—contributed during the year
- Share of the partner’s profits and losses
- Distributions for personal use
Take a look at one example: Let’s say two people form a limited liability company and decide to split ownership down the middle—each taking 50% of the profits and losses. Each owner invests $25,000, so each capital account starts out with $25,000.
The business does well during the first year and earns $60,000. Each owner’s capital account increases by $30,000 for an account balance of $55,000 per owner. But during the year, Owner A and B each took $10,000 out of the business for personal use. Here’s a simplified look at how the changes might be tracked:
| Owner A | Owner B | |
| Initial contribution | + $25,000 | + $25,000 |
| Profit allocation | + $30,000 | + $30,000 |
| Distribution | – $10,000 | – $10,000 |
| Ending capital account balance | $45,000 | $45,000 |
Bear in mind that this simple calculation is intended to give you an idea of how capital accounts work and what they look like. If the ownership isn’t a 50/50 split or if one owner takes a larger distribution, the numbers will get complicated—and depending on the parameters outlined in your governing documents, your business may need to abide by some unique rules. Talk to an accountant to be sure that you’re setting up and tracking your capital accounts properly.
Reporting capital accounts on tax forms
Owners typically keep tabs on each member’s capital account and basis throughout the year using spreadsheets or accounting programs. At the end of the fiscal year, the ending balance in the account represents any money or assets that have not been distributed to the partners. The tax you pay depends on the distributions you take and the structure of your business.
If you have a pass-through entity like a sole proprietorship or a single-member LLC, any profits or losses are passed on to the owners. If your business is set up under one of these structures, you’ll record profits on your personal tax return via Schedule C of Form 1040.
Partnerships will prepare Schedule K-1 as part of Form 1065, while an S corp prepares Schedule K-1 as part of Form 1120S. This tax form reports changes to the capital account to the IRS. It’s important to get this right because the tax agency uses the information on Schedule K-1 to make sure the account changes match your income and balance sheet reporting. If you’re unsure, talk with your accountant to see if you need to file this form and whether you must fill out a state-specific Schedule K-1.
Capital account FAQ
What is the difference between a capital account and a drawing account?
Capital accounts and drawing accounts are both financial accounts, but they have different uses. A capital account is a long-term official record of your personal financial stake in your business, including your contributions, distributions, profits, and losses. A drawing account, on the other hand, is a short-term account to house the funds you’ve withdrawn from your capital account for personal use. The capital account is for your initial business investment and earnings, whereas a drawing account is a current account for the personal funds you’re taking out from your share of business earnings.
Can a capital account have a negative balance?
Yes, capital accounts can go negative for a couple of different reasons, the most common being when you withdraw more money from your capital account than your business is bringing in. This can happen with personal withdrawals, but it can also happen with loss allocation in a partnership. If your business is losing profits, you have to distribute those losses among the partners. If one partner’s share of losses is bigger than their personal contributions to the business, their capital account balance will go negative.
What is the role of a capital account in a partnership?
Setting up individual capital accounts in a partnership is a good way to clearly understand each partner’s unique equity and ownership stake in the business. You’ll see each person’s initial capital investment, their share of profits and losses as the business builds, and how many distributions or withdrawals they’ve made.
How does a capital account impact shareholder equity?
Your capital account shows how your shareholder equity changes over a period of time, based on how much you contribute to or withdraw from your capital account, and how your business performs.
What transactions affect a capital account?
Capital account transactions that affect your balance include: contributions (when you add money or fixed assets to your account), withdrawals and distributions (when you pull money out of the account for personal use), and profits and losses (the business’s earnings and losses).
What is the balance of payments?
When you’re researching capital accounts for your business, you might come across the term balance of payments. A balance of payments refers to a country’s record of international transactions (including international trade) with the rest of the world; part of that country’s record-keeping process is establishing a capital account. Don’t worry, though—you don’t need to set up a balance of payments for your own business!
What are capital markets?
A capital market is a financial market (like a stock market or foreign exchange market) where you can exchange funds like stocks and bonds.
