I am a California resident who has invested in a private placement LLC registered in Delaware. The LLC's office is in Reno, NV, and they are building houses in Montana. Montana is wanting to collect taxes on a portion of the annual returns from this LLC. I have no idea how they calculate the percentage of the distribution that is taxed. To help understand the situation, the subscription agreement of the LLC, states the following:
Section 4.1 Distributions.
Except as otherwise expressly provided in this Agreement, Distributable Cash shall be distributed as follows (after payment of any Priority Loans, if any):
A. Distributions of Distributable Cash. Distributions of Distributable Cash shall be in the following order of priority:
(1) First, to each Investor Member, in proportion to each Investor Member’s
Adjusted Invested Capital, until each Investor Member’s Adjusted Invested Capital has been
reduced to zero;
(2) Second, to each Investor Member until each Investor Members has received all of its respective Preferred Return, in proportion to each Investor Member’s share of the aggregate Preferred Return; and
(3) Thereafter, (i) thirty five (35.0%) to the Investor Members, Pro Rata, (ii) ten percent (10.0%) to the Founding Syndicated Member, (iii) forty percent (40%) to the Founding Member, and (iv) fifteen percent (15%) to the General Contractor.
Notwithstanding that the distribution to the General Contractor will be paid at the same time as payments to the Founding Member, the Investor Members and the Syndicated Investor Member under Section 3.4.A(3), the General Contractor is a not a member of the Company and such amounts will be treated as expenses of the Company and not distributions.
Section 4.2 Timing and Calculation of Distributions.
Distributions of Distributable Cash shall be made at such times and in such amounts as reasonably determined by the Managers.
According to the above excerpt from the Operating Agreement for the LLC and the fact that the amount returned so far equals the amount that I invested, I should not owe any taxes at all since I have only received returns of invested capital. In fact, my investment was funded with both Roth and traditional IRA money, so I should not owe any taxes at all until I withdraw the portion of funds from my traditional IRA that was attributed to this investment. And even at that point, I would not owe any taxes to Montana for anything. I would be paying taxes only on the portion of the profit from the investment (items 2 and 3) that was funded my traditional IRA, and not any taxes on the invested capital. These taxes would be paid on these distributions to the IRS and to the state where I reside, California. Am I missing something in my understanding of the way investments are taxed?
