Get your taxes done using TurboTax

Well, I am going to deliver the bad news; or at least it is bad based on limited facts:

• The economics of the LLC appear to be convoluted.
• Your facts indicate that you own 50% of the LLC but only 7% of the investment.  Having an allocation that is not in accordance with the member's interest (known as PIP partners interest in the partnership) in the LLC, must now meet the requirements of the very complicated Section 704(b) regulations.  These regulations are not for the unseasoned tax professional.
• Your facts indicate that there are other "investors" that only had a profits interest.  That doesn't make any sense in the partnership world for your fact situation.  A profits interest is typically provided to a member that is a key "employee" to the LLC.  A profits interest member only receives an allocation when an LLC generates income or has positive tax capital to allocate losses.  A profits interest member also does not contribute capital to an LLC.  So based on the limited facts, I'm not sure how the profits interest member's receive any allocation if there was no profit; certainly there was no profit generated by the R&D project based on the facts.
• Without actually seeing a form 1065 and how everything was presented, there is not much more I can provide here.
• I strongly suggest that you find a tax professional that is strong in partnership tax and can work through the issues.
• Based on the limited facts, the investors that you are saying are "profits interest only" should most likely be treated as individuals that loaned $$ to the LLC to fund the R&D project.  These individuals would not receive any K-1 but would just have their loan $$ repaid as received from the lawsuit.
• Bottom line, I think someone started down this path not understanding partnership tax, but I certainly don't believe there is $600,000 in income to be reported.
• At the end of the day, if you truly have unused passive activity losses, since these are carried forward indefinitely, you won't lose the ability to utilize them when the LLC terminates.  This assumes you have tax basis; which is a whole different discussion.
• Get qualified help.  Don't be penny wise and pound foolish here.  And get it done this summer when tax professionals have more time to deal with this before the extended return deadlines.