LLC partnership 50/50 ownership, but only one of us funded startup capital. How should I file Sched Ks since capital only came from one party?

[joshisaking]

We set up the LLC in 2016 as a 50/50 ownership, with the agreement each would contribute $3500 of startup capital. However, my partner soon after experienced a job change that kept him from providing his $3500, so only mine was reflected in our capital account. We did not publicly launch the business in 2017, but continued to pay monthly expenses. We did not make any profit. In Jan 2018 we dissolved the LLC. 

How should I fill out Sched Ks for my partner and I, since the only capital was my own? The LLC was formed to split 50/50 profits and losses, but that was with the understanding we both contributed $3500. Since he never did, and all annual expenses were paid out of my capital, how should I fill out final Schedule Ks? 

[Rick19744]

Did you file a return in 2016?

[joshisaking]

Yes, as a 50/50 owned LLC partnership.

[Rick19744]

You indicate that "we did not publicly launch...."   This indicates that you never really started your trade or business.  What was reflected on the 2016 tax return?

[joshisaking]

Got it, sorry for the confusion. In 2016, we were registered in VA and had some online apparel sales there, but not enough to be profitable and split the losses 50/50 since we split the capital. So we issued Schedule Ks to reflect those split losses and filed our returns. In 2017 we moved and registered the business in FL, at which time we "start from scratch" with our capital contributions as a baseline. At that time I contributed my $3500, and shortly after he changed jobs and could not match my contribution. So at that point I owned 100% of the capital. So in 2017, we launched our website publicly but never launched actual apparel sales, so generated no profit, only losses due to business expenses. Those expenses were paid out of my $3500 in capital. Hopefully that clears some things up. So (1) what if any forms should I complete to denote this capital ownership change, and (2) how should I fill out Schedule Ks this year? The business has since been dissolved, so this is the final Schedule K.

[Rick19744]

LLC's taxed as partnerships are complicated and difficult to address when not in a face to face situation.  So hopefully my final questions are as follows:
1) Where was the LLC organized (this is the legal step of setting up with the state.  This is different that just registering to do business in a state)?
2) In 2016 did you both make capital contributions?
3) At the end of 2016 what were each of the capital account balances?
4) No debt from any outside sources; banks, etc?
5) Assume you filed a VA return as well?

[joshisaking]

1) Organized in FL

2) We simply split the startup costs down the middle...so no actual contributions into an account, but rather divided expenses 50/50. In other words, when a bill came in, we each paid half out of our individual accounts.

3) Again, no capital account balances per se, only shared losses we split on our Schedule Ks. It was a 50/50 ownership.

4) No debts.

 5) Yes, we filed a VA return.

Sorry for the complication...I can appreciate your comment about resolving these face-to-face.

[Rick19744 · Accepted solution]

Ok.  Comments as follows:

1. As members in an LLC taxed as a partnership you need to maintain a schedule of your basis in the LLC.  This begins with your capital contributions and is update annually for the applicable lines on the K-1.
2. What you had in 2016 were in fact capital contributions to the LLC and then the LLC had the offsetting expense.  Hopefully this is what was reported on the 2016 form 1065 and Schedules K-1.  
3. Appears that the 50/50 reporting was appropriate in 2016.
4. Not sure you actually had a formal capital / ownership change.  What happened is one member contributed additional funds.  The way the tax code works is that allocations need to have substantial economic effect.  A complicated concept, but at the end of the day, it just means they need to make sense economically and no shifting of the economics.  In your case, to maintain substantial economic effect, you should be allocated all losses to the extent of your additional $3,500 contribution.
5. In order to obtain the result noted in item 4, you either need to change the profit and loss allocation to 100% for you, but leave the capital percentages as 50/50, or you may need to go into the special allocation section and override the allocation.
6. What I don't know without actually seeing a return, is whether this is the end?  This should mean that the one member gets nothing, since they had no capital / basis at the beginning, and with your allocation you should also end up with close to zero capital / basis.
7. There shouldn't be any cash to distribute so I would imagine that the balance is zero at the end of the period?
8. You should file a final VA return to notify the state that the LLC will no longer be filing.
9. Since you registered in FL you should probably file an initial and final FL-1065 as well. 
10. Some Secretary of State offices require an annual fee until a business "unregisters".  You may want to follow up with each state to see if this is required so you don't end up have to pay additional fees.

[joshisaking]

This is incredibly helpful! Thanks so much for providing some clarity to this otherwise murky situation!

[Rick19744]

You're welcome.

[pvanhoesen]

Hi Josh and Rick, I had a similar situation with a different twist.  
I have never been a capital contributor to one of my LLC's (TN-member-managed) but I did own an equity stake (sweat equity).   For the first two years our former CPA was allowing me to share in the losses of the company according to my sweat equity percentage (less than 5%).  

At the same time the company was paying me a Guaranteed Payment for my work with the company and they were attributing losses to my share percentage in Box 1. This offset about 1/3rd of my guaranteed payments in box 4 so my reported Self Employment Earnings in Box 14 A were only 2/3rds my guaranteed payment. This substantially reduced my tax obligation on the guaranteed payment - nice.

Then a new CPA decided to do what Rick said above and stopped allocating any loss to me which made my Box 14 Self Employment Earnings equal to my Guaranteed Payments. My personal tax liability went up...

I am assuming the LLC can allocate losses any way it chooses as long as the "substantial economic effect" rule is maintained. The losses allocated to me were less than 5% of the total losses (we were not profitable yet) so the "substantial economic effect" was allocated to the other 95% of people who had capital in the game.   

The new CPA is arguing differently...  

Thoughts on that situation?

[Rick19744]

If you don't have any capital invested or basis accumulated, then you don't have any economic effect, let alone substantial.
Guaranteed payments do not impact your basis, so if your LLC was just generating losses, you have nothing invested.
This is a complicated area.
What you are receiving is a profits interest and the LLC had not generated any profit based on your facts.
Unfortunately many CPA's lack a strong understanding of this complicated area.
Your new CPA appears to understand the concept better than the original.