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Tax work may not seem adventurous to some. Surely the average person sees nothing of the fantastic in it. There is nothing like a little house on the prairie that, taken by a great wind, ends up in a country of greensward and flowers.
Yet the practitioner may see the connection when it comes to target allocations. In both cases, you are not in Kansas anymore.
Target allocations have become the rage in drafting partnership allocations of income, gain, loss, and deduction. It often seems like practically everyone uses target allocation provisions, yet it is not clear how much anyone understands them. Most drafters pay little attention to the question of whether target allocations actually have any effect on tax allocations at all. Most stumble on the fine detail of target allocation provisions. Many do not understand the target allocation provisions that they use. Perhaps no one fully does, but most drafters are not well informed of the many subtle questions involved in drafting target allocations.
Target allocations also are ideally suited, and are widely used, for tax reduction or tax avoidance in certain situations. They are often used by partnerships, in effect, to deduct the retirement payments to retiring partners. The partnership's deduction can vastly exceed the amount paid to the retiring partner. The retiring partner may have no increased income on account of the target allocation, since the increased allocation either (1) offsets income that he or she otherwise would have on liquidation or (2) produces a capital loss. Furthermore, some abusive schemes for tax reduction or tax avoidance can be undertaken with target allocations.
This is the second of the two installments of this article. Like the first, it will explore, but not resolve, many questions about target allocations. The road through the authorities on target allocations is a long Yellow Brick Road through a great, dark Enchanted Forest. The target allocation provisions may be a black box that few people, if any, can understand completely. They may be merely decorative touches that, like the Wizard, may be more illusion than substance. There are subtleties worth considering in drafting target allocation provisions. There are ways to judge whether a provision is perfect, or to judge whether a perfect provision is possible.
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