LLC Form 1065 with no Schedule L

Working on a LLC Form 1065 tax return.

The gross sale just exceeds $250,000.

So Schedule L is required.

Have been asking client for the assets, liabilities, owners' equity, etc information.

Waited and waited.

Today called again, Client said it was too much trouble to look up the information so he asked me to just skip the Schedule L.

Question (1): Would you skip the Schedule L and e-file the tax return based on the client's own decision and wish?

Question (2): Would the LLC tax return be rejected if efiled without the Schedule L?

Question (3): What are the potential consequences of filing a LLC tax return without the Schedule L while it's gross receipt exceeds the threshold?

1) I certainly would not give a client an incomplete tax return for filing, or attempt to e-file it. Then again, I don't even like to finalize ANY 1065 or 1120 without the balance sheet even when not required.

2) Will your software even allow you to e-file a return without a required schedule?

3) $210 per month per partner to a maximum of 12 months. See § 6698(a)(2); the amount has been adjusted for inflation.

[ . . . ] Client said it was too much trouble to look up the information [ . . . ]

"Look up" the information??? The balance sheet as of December 31, 2018? Too much "trouble" for the client to "look it up"?

Good grief.



Sadly, over the years, probably most of us have had clients like this.

Client is talking with his employee:

Now that pesky tax return preparer wants something called a "balance sheet". Man, don't these people understand I have a business to run here? I don't have time to look for old paperwork! Jim! Hey, Jim! Do you know where we keep the "balance sheets"? What's that you say? Well, look around! Maybe they're in one of those boxes in that stack behind the water cooler!

Re 3: If you can even file the return, I would expect your client to receive a notice. It's easy for the IRS and CA to scan for a 1065 with gross receipts over $250,000 and no balance sheet.

Could you subject yourself to a preparer penalty?

Are you saying the client does not have books? If they have books, there's a balance sheet. How are you keeping track of basis and capital accounts?

Seriously. Meet with him and you should be able to piece it together in 15 min!
Give me your year end bank statement
You should already have depreciation schedule.
Cash or accrual...?

do you have any loans? Give me statements....

That's 90% of them.

Bigger issue, no one's keeping books? Let's get him started on that if not...if he 'thinks' he's running a business, he's not without some information.

3) $210 per month per partner to a maximum of 12 months. See § 6698(a)(2); the amount has been adjusted for inflation.

§ 6698(a)(2) says the penalty may be waived with 'reasonable cause'.

The problem now is that one partner took a sum of money from the LLC in 2018. But as of today, the two partners still cannot come to an agreement as to what it was, whether it was 'distribution' or 'loan' or something else.

Without coming into an agreement, there is no way to put together a balance sheet that both partners will accept and agree to be correct. Would this situation be considered a 'reasonable cause' of not being able to provide a balance sheet?

How would you handle the situation?

Easy: if there's no loan agreement in place, it's a distribution. It doesn't matter what the partners say.

I would let the partners know that's how the amount is treated, prepare the balance sheet accordingly, and send the return along with e-file authorizations to the tax matters partner. Also let both partners know what will happen if the return isn't filed on time.

Easy: if there's no loan agreement in place, it's a distribution. It doesn't matter what the partners say.

I would let the partners know that's how the amount is treated, prepare the balance sheet accordingly, and send the return along with e-file authorizations to the tax matters partner. Also let both partners know what will happen if the return isn't filed on time.

Thank you for your opinion. I see your point that it would only be a loan if there was an loan agreement. However, I have seen in this forum many times before that someone suggested calling an undetermined transaction a 'loan', such as when a LLC or a Scorp paid an personal expense of a shareholder in one year and then got reimbursed by the shareholder in the following year.

Also, would you feel comfortable to make the determination for them that it was a distribution when the two partners are going tooth and nail against each other on it? Let's say Partner A took the questionable withdrawal from the LLC and Partner B fiercely wants the money back. If you call it a 'distribution' for them, that means Partner B would lose the recourse to go for the repayment. Would you be subject to potential legal action by Partner B?

In addition, what about if the worse comes to the worse and Partner B considers it neither a distribution nor loan, but an 'embezzlement' instead. In this situation, I just cannot see how you can be in the position to make the decision for them that it was a distribution.

The situation over there in the LLC is extremely complicated.

Also, would you feel comfortable to make the determination for them ...

The rest of the circumstance is unnecessary to have the correct answer, which is NO.

They have issues they need to settle. It is not and should not be our role to determine the substance of transactions. If they want input as to how to best plan for a transaction or guidance as to how to treat something in the most advantageous manner to meet a goal, we have the expertise to help them make a decision. It is ALWAYS their decision to make.

In a situation as you've described, any course of action other than waiting for their agreement will likely result in your inserting yourself into their conflict. That isn't a positive for you.

The best approach here is likely to inform them of: the consequence of late filing; the latest date you need to have information to complete a timely return (including Sch L); and a bill for the work you've done to date, if significant.

I would feel comfortable making the determination. The reason is that it's a tax determination of the effect of a transaction and not an opinion regarding the liability of Partner A to repay the money to the partnership.

When a partnership purports to loan money to a partner, the two taxpayers are attempting to establish a relationship other than that of a partnership and a partner. In order to establish such a relationship, there needs to be affirmative arms-length evidence of it.

The mere fact that a withdrawal is a distribution and not a loan does not mean the withdrawal was authorized. Either the partnership agreement prohibits the withdrawal or it does not. If it does, Partner B doesn't lose legal recourse because of the withdrawal's tax characterization. If the agreement doesn't prohibit the transaction, then it doesn't matter what the transaction is called.

It is not and should not be our role to determine the substance of transactions.

Of course it's our role. We can be sanctioned by the IRS for going along with false claims for tax benefits that lead to understatements of tax, and in some cases for presenting false information even if there's no change in tax. Business transactions, at a minimum, need to pass a "smell test" before we should put them on a return. If the taxpayer claims $10,000 of meals expense for no apparent reason, you are obligated to question the substance of those transactions as ordinary and necessary business expenses.

It is ALWAYS their decision to make.

And when the tax matters partner signs a return with a balance sheet that shows the withdrawal being deducted from equity, that's ultimately his decision and a representation of a position that he takes. If Partner A doesn't agree with the decision, he isn't legally bound by it. The tax preparer's role in all of this is limited: he's simply suggesting the most reasonable position, for tax purposes, based on the facts available.

I would feel comfortable making the determination. The reason is that it's a tax determination of the effect of a transaction and not an opinion regarding the liability of Partner A to repay the money to the partnership.

It is not and should not be our role to determine the substance of transactions.

Of course it's our role.

Maybe you misunderstood my statement. In this circumstance, you have two partners who do not have agreement upon the substance of a transaction. The form is clear -no loan documents, not a loan-, but the substance is not. By inserting yourself into this discussion, you risk a lot more than the loss of a client.
The tax treatment of transactions follow the substance and form (or form and substance). They are not separate.

If you have two partners that have yet to come to an agreement on a transaction that has occurred many months ago, you have a dysfunctional business partnership. I might choose to mediate the discussion, but I'm not going to unilaterally characterize a transaction when I know there is active disagreement.

In this circumstance, you have two partners who do not have agreement upon the substance of a transaction.

From the facts presented, their disagreement would appear to be whether the amount should be restored to the partnership or not. Whether it should or shouldn't doesn't affect the tax characterization of the withdrawal. For tax purposes, certain things need to happen for a presumptive loan between related taxpayers to be respected as a loan. As of today, those things haven't happened. If this condition persists through the date of filing, then the withdrawal is unambiguously a distribution.

I'm not going to unilaterally characterize a transaction when I know there is active disagreement.

You wouldn't be unilaterally characterizing anything. You would be applying, in good faith, a tax law concept that may appear to be related, but which is ultimately unrelated, to the partners' dispute. The position would only become final and binding on the partnership once the tax matters partner endorses it.

I would feel comfortable making the determination. The reason is that it's a tax determination of the effect of a transaction and not an opinion regarding the liability of Partner A to repay the money to the partnership.

When a partnership purports to loan money to a partner, the two taxpayers are attempting to establish a relationship other than that of a partnership and a partner. In order to establish such a relationship, there needs to be affirmative arms-length evidence of it.

The mere fact that a withdrawal is a distribution and not a loan does not mean the withdrawal was authorized. Either the partnership agreement prohibits the withdrawal or it does not. If it does, Partner B doesn't lose legal recourse because of the withdrawal's tax characterization. If the agreement doesn't prohibit the transaction, then it doesn't matter what the transaction is called.

I guess the discussion has somewhat ventured into legal area. The difficulty here is that none of us are lawyers. We can only speculate the potential legal effects eventually. Lets just imagine the conflict unfortunately goes to court and the judge rules that Partner A wins as he presents the balance sheet on the tax return as one of his arguments. In this case, would Partner B turn around to file a lawsuit against us as the balance sheet has partly contributed to him losing the legal recourse on the repayment? This is a legitimate concern that we have to consider before jumping into the fire to make the determination for them.

Ok, maybe #9 was a bit too aggressive. How about this:

Contact both partners and inform them that due to the absence of an arm's-length contract, etc., etc., the withdrawal should be treated as a distribution for federal tax purposes. Then, present the balance sheet as it would look if it matched the tax treatment. Finally, ask both partners if they agree with filing the return that way. If one or both disagree, ask them how the return should be filed. If you don't get an answer, let them know what the penalties are and leave it at that.

Said differently, don't file a return when the partners are in disagreement.