•Essentially, there is a general rule and 5 exceptions.•As a practical matter, one looks to see if an exceptionapplies and resorts to general rule only if none of theexceptions apply.•The general rule ( §704(a)): “... partner’s distributiveshare ... determined by the partnership agreement.”•Exceptions:•The substantial economic effect exception §704(b)•The contributed property exception §704(c)•Varying Interests §706(d)•The “gift” partnership exception §704(e)•The “nonpartner capacity” exception §707(a), (c)Partnership Allocations: Overview
Unless the gift, contributed property, varying interests, orpartner noncapacity exception applies, p’ship items ofincome, loss, gain, deduction, credit are allocatedpursuant to the partnership agreement. §704(a)But if the allocation lacks substantial economic effect,it is disregarded and the item is allocated in accordancewith the partner’s interest in p’ship §704(b)(2)If there is no allocation in agreement, the item is allocatedin accordance with the partner’s interest in p’ship§704(b)(1)Special allocations: statutory construct
•Reg approach: is allocation valid?•Allocation is valid if it meets one of these three:1.704-1(b)(1)(i)•Substantial economic effect 1.704-1(b)(2)•In accordance with interests in p’ship 1.704-1(b)(3)•Deemed to have substantial economic effect1.704-1(b)(4)•Reg structure•1.704-1 (exc. for one rule in 1.704-2) [hereafter -1, -2]•complexity and difficulties•depth of subdivision via use of -1 and not -1 thru -n•internal cross reference by long cite & not name•layout/white space/marginationSpecial allocations: regulatory construct
(i) 2-prong definition (substantial economic effectrequires economic effect & substantiality)!(ii) Economic effect(a) Concept: tax allocation of item to partner whobears actual economic burden or gets actualeconomic benefit(b) 3-prong mechanical test:(1) capital accounts properly maintained(per rules in -1(b)(2)(iv))Special allocations: reg construct -1(b)(2)(2) liquidations set to follow capital accounts (3) obligation to restore deficits in capital accounts. . . . . .(e) allocation can have partialeconomic effect(iv) Capital Account Accounting Rules (next slide)
Special allocations: reg construct -1(b)(2) (ct’d)First, need to understand basics ofcapital account accountingCapital account is increased bymoney contributedFMV of property contributedincome and gain allocated to partnerCapital account is decreased bymoney distributedFMV of property distributedloss and deduction allocated to partnerNote: FMV, not AB, of contributed/distributed propertyUnaffected by share of partnership liabilitiesCapital account can be negativeHence, ABPI usually not the sameas capital acctSo what does this mean?
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Economic system, partner, Call-sign allocation plan, Capital accounts