2 order of substantiality tests first depending on

2. Order of Substantiality Tests. First, (depending on the timing of the
allocations) apply either the Shifting Tax Consequences Test or the Transitory
Allocation Test. Then, apply the After Tax Test. Finally, apply the General Test.
3. Shifting Tax Consequences Test. The economic effect of an allocation is not
substantial if, at the time the allocation becomes part of the partnership
agreement , there is a strong likelihood that
a. (1) the net increases/decreases recorded in the partners’ capital
accounts will not differ substantially than what they would be in the
absence of the allocations, AND
b. (2) the total tax liability of the partners will be less than if the
allocations were not contained in the partnership agreement. Reg. §
1.704-1(b)(2)(iii)(b).
4. Transitory Allocation Test. If a partnership agreement provides for the
possibility that one or more allocations (“original allocation”) will be largely
offset by one or more other allocations (“offsetting allocation”), the economic
effect of these allocations are not substantial if at the time the allocations
become part of the partnership agreement there is a strong likelihood that
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a. (1) the net increases/decreases recorded in the partners’ capital
accounts will not differ substantially from what it would have been in
the absence of the allocations, AND
b. (2) the total tax liability of the partners will be reduced from what it
would otherwise be. Reg. § 1.704-1(b)(2)(iii)(c).
5. After Tax Test. The economic effect of an allocation is not substantial if, at the
time the allocation becomes part of the partnership agreement ,
a. (1) the after-tax economic consequences of at least one partner may ,
in present value terms, be enhanced compared to such consequences
if the allocation were not contained in the partnership agreement, and
b. (2) there is a strong likelihood that the after-tax economic
consequences of no partner will, in present value terms, be
substantially diminished compared to such consequences if the
allocation were not contained in the partnership agreement. Reg. §
1.704-1(b)(2)(iii)(a) (second sentence).
6. General Test. The economic effect of an allocation is substantial if there is a
reasonable possibility that the allocation will affect substantially the dollar
amounts to be received by the partners from the partnership, independent of
tax consequences. Reg. § 1.704-1(b)(2)(iii)(a) (first sentence).
7. Problem 2 (p. 162). C and D are equal partners in a general partnership formed
to design and produce clothing for sale to retailers located throughout Europe
and the United States. D is a nonresident alien. At the beginning of the tax
year, the relative dollar amounts of United States and foreign source income
cannot be predicted. Any foreign source income allocated to D is exempt from
United States taxation. Assume that all of the following allocations have
economic effect.