When starting a business venture, there are different ways to classify your entity. Business owners are wise to consult an attorney and accountant before deciding on the most advantageous classification. Some vary in tax advantages and their different ways of tracking equity. The company’s equity is essentially it’s capital-the difference between its assets and liabilities.
A company’s equity increases when it makes profit as well as when its owners invest money into it. A company’s equity decreases when it experiences profit loss or when its owners withdraw money from the company. “Equity accounts track the net effect of all your company’s past transactions and are the starting point in calculating the value of your business” (Accounting Savvy for Business Owners p.131).
Each partner must have his/her own equity account designated in the chart of accounts. This will make it easy when you need to print out records and data for each partner’s personal tax return. Initially, record each partner’s contributions to the company in his/her individual equity account. Throughout the tax year, record any additional funding in the same way.
Depending on the partnership, each partner might have a different percentage of ownership and therefore, receive a different percentage of the profits. A withdraw of money by a partner is not considered an expense. Instead, it is classified as an “equity transaction.” Paying expenses for a partner’s health insurance or retirement plan can not be considered deductible business expenses as they are when paid out for employees. Instead, these payments are posted to each partner’s equity account.
To ease confusion, it is recommended that each partner have a business and personal credit card. He/she must seek to only pay for business expenses with the business card. This will simplify the accounting process.