When establishing a new single-member limited liability company (SMLLC), you’ll want to provide some kind of initial investment in the business. This type of pay-in is technically known as a capital contribution. Most often, a capital contribution will be in the form of cash—for example, you invest $5,000 of your personal savings in the new SMLLC. However, LLC laws allow for several different kinds of capital contributions, including:
Whatever you contribute—money, property, or services—becomes the property of the SMLLC.
An initial capital contribution is commonly seen as being given in exchange for membership in an LLC. However, while not typical, a person could contribute something to a company without being given membership, and a person could also be given membership without making any contribution.
Making an initial contribution is strongly recommended. While most people do make an initial capital contribution, legally it is not required. You could simply appoint yourself as the sole member of your SMLLC without making any initial investment. However, you’d probably be taking a significant risk if you didn’t invest at least a small amount at the outset. Without any capitalization, your business may not appear to be truly separate from you, personally. In other words, without any initial contribution, if your business is responsible for someone being injured, or incurs a debt that it’s unable to pay, a court might decide that your company suffered from inadequate capitalization. It therefore might allow someone with a claim against your business to “pierce the veil” of limited liability associated with your SMLLC, and go after you, personally, for restitution.
Making a money contribution can be very simple: You write a check from your personal account and deposit it in your new business account. Moreover, you don’t necessarily have to invest a large amount—for some very small businesses, a few hundred dollars might be plenty. The main point is to pay in enough money to meet your initial expenses. Then, going forward, it’s important always to keep enough capital in your business to meet your reasonable, ongoing expenses. (This last point is generally a requirement under states’ LLC laws.)
Making a contribution in the form of property or services can be somewhat more complicated. The complications mainly relate to potential tax consequences. In most cases, a key issue will be determining the dollar value of the property or services contributed.
For example, if you contribute a piece of real estate you already own that is worth more than when you first acquired it, you’ll need to know how much the value increased before you contributed it to your new company. Then, if you ever sell your membership—in effect, sell your company—you’ll have to pay taxes on that amount of increased value. Similar tax issues arise relating to property value if you take profits from your company within two years of the date that you contribute the property. Briefly, the IRS may view the taking of profits in such cases as a disguised sale of the property. For further guidance on this point, you should consult with a tax professional.
EXAMPLE: Five years ago, Rudy bought a very small office building for $30,000. It is now worth $50,000. When he forms his new SMLLC, Rudy transfers ownership of the office to the SMLLC as a capital contribution. Rudy makes sure to record that the value of the property increased by $20,000 between the time he bought it and the time he contributed it to the SMLLC. In addition, if Rudy wants to take money out of the company to pay himself during the next two years, he’ll speak with a tax expert to make sure there won’t be any problems with the IRS thinking he actually was trying to sell the property rather than contribute it.
If you intend to contribute services in exchange for your membership, you’ll need to record the value of those services on your company’s balance sheet. In turn, you’ll need to pay taxes on the value of those services, just as if you’d been paid for them as an employee.
For any LLC, an initial contribution usually is exchanged for some portion of ownership in the new company. This ownership portion is called a capital interest. A member’s capital interest generally is equal to the percentage of the company he or she owns. While figuring out this percentage can sometimes be complicated in the case of multi-member LLCs, in the case of an SMLLC the matter is straightforward: The single member clearly has a 100% capital interest in the company.
For additional information about forming an SMLLC, check out the other articles covering formation in the SMLLC section of the Nolo website. For detailed questions regarding tax implications of capital contributions, check outirs.gov or speak with a tax expert.