Decoding the tax return of your Syndicated LLC - related party transactions

[Bruce D. Kowal]

We affirmed the absolute rights, set forth in your State’s LLC Law, for ANY Member to request copies of the three most recent years Federal and State tax returns issued by the LLC. 

As well as financial statements. Including the Statement of Cash Flows.  [Topic of a future post]

Why? Those returns will give you some insight into the integrity of the Syndicator, as well as raise red flags of a possible Ponzi scheme taking place with your money.

Let’s look at the balance sheet again on the IRS Form 1065. Go to this link, the IRS Form 1065. Scroll down to page 6, Schedule L, Balance Sheet per Books.

https://www.irs.gov/pub/irs-pdf/f1065.pdf

Look at Lines 7a and 19a. These are the outstanding balances of loans to and from Partners and Related Parties. It actually says “Loans to Partner (or persons related to Partners)”. Notice that the next lines 7b and 19b are for actual Mortgage Loans. This helps with disclosure. You don’t want the actual mortgage loan mixed up with loans to and from Partners.

Who are Partners? Could be an individual Member of the LLC. Or could be another LLC formed by the syndicator. 

For example, you invest in 100 Main Street LLC. You look at this balance sheet and you see $500,000 in loans to 200 Walnut Street listed on Line 7a. Huh? [It will appear as part of a supplementary statement to the tax return. If there is no explanation, ask for one]

Why on Earth is YOUR LLC owed money by 200 Walnut Street LLC? That means that some of the cash you invested in 100 Main has been loaned to 200 Walnut Street. Got that?

And why-oh-why would that happen? Well, maybe the Syndicator of YOUR LLC, 100 Main Street, also has formed 200 Walnut Street, and is short of cash. Why? Well, maybe he took too much out for himself. Just sayin’. And the new money coming in to 100 Main is a good source of cash to make up the shortfall. . .

You see how this goes? You may be in a Ponzi scheme. Maybe. This goes for the other side of the balance sheet, where the LLC now OWES money to another LLC. Same reasons.

Here's the thing, though. Another right of an LLC Member is to get copies of all Operating Agreements. Read the Operating Agreement.

Is your LLC authorized to incur debt without Investor approval? 

Here are five dangerous provisions to watch for in an Operating Agreement:

Dangerous Provisions to Watch:

Authority to incur debt without investor approval

Power to make loans to other entities/projects

Ability to cross-collateralize with other properties

Permission to use investor capital for other ventures

Commingling of funds across different projects

Why These Are Potential Ponzi Indicators:

• New investor funds could be used to pay existing investors

• Project-to-project lending can mask poor performance

• Cross-collateralization puts your investment at risk for others' failures

• Commingling enables masking of financial problems

• Lack of project segregation enables fraudulent schemes

Protective Measures to Look For:

Strict single-purpose entity requirements

Project-specific bank accounts

Debt limitations and investor approval requirements

Prohibited related-party lending

Clear fund segregation requirements

Professional Best Practice:

Request bank statements showing separate accounts for each project. If a sponsor resists this basic transparency measure, consider it a serious warning sign.  We discussed this in an earlier post.

Obviously, if loans are being made without any provision in the Operating Agreement, it’s time to get in touch with your State Securities Protection Division - usually a part of the State Attorney General Consumer Protection Agency. Here is NJ: https://www.njoag.gov/about/divisions-and-offices/office-of-...

And then you could contact SEC Enforcement: https://www.sec.gov/submit-tip-or-complaint

I have found that a carefully written letter to the Syndicator, alerting him that you are suspicious, will get you a quick refund . . . under certain conditions. Your first step is to contact a savvy CPA.

You, as a Member of an LLC, by virtue of the LLC records provisions in the LLC law, have as much disclosure access, and more, than a shareholder of a public company.  

Try getting a copy of Tesla's tax returns . . ."Hey, Elon, Buddy.  Now that you are in charge of DOGE, can you send me a PDF of the Tesla Consolidated Tax Returns, Federal, State and City  for 2023, 2022 and 2021?"

Assert your rights!!!

A reputable Syndicator will be glad to disclose information pursuant to the LLC law, Period.

[Disclaimer: This information is a service to Clients and other readers for educational purposes only. Nothing in this post should be construed as, or relied upon, as legal advice or as creating a CPA-client relationship.]