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Abstract
Code Sec. 704(a) allows partners in a partnership to allocate items of partnership income, gain, deduction and loss by agreement. This allocation flexibility can be a significant advantage of the partnership form over an S corporation, as S corporations must allocate items on a per-share, per-day basis. However, this potential advantage comes at the cost of added complexity, as Code Sec. 704(b) will not respect the partners' agreement if the allocation lacks substantial economic effect. Partnership allocations must also take into account items of built-in gain or loss pursuant to Code Sec. 704(c) and its regulations. Preparers of partnership tax returns have been accustomed to partnership agreements that prescribed a particular allocation of income, gain, deduction and loss among the partners. The preparer exercising due diligence would then evaluate the partnership agreement for compliance with one of the safe harbors for economic effect found in the Code Sec. 704(b) regulations.