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The path down the rabbit hole is a tortuous one.
Partnership taxation is an adventure in Wonderland, and partnership allocations are a chase after an elusive White Rabbit.
Drafting partnership allocations of income, gain, loss, and deduction can test the skills of the best partnership advisors. Partnership deals can be complex. Partnership tax laws are complicated and often ambiguous, and sometimes seem not to make much sense. Regulations become old, musty, and worm-eaten. In this they can be like a book "without pictures or conversation." As Alice might add, "what is the use of a book ... without pictures or conversation." While it will offer neither pictures nor conversation, the following discussion at least will endeavor to "[b]egin at the beginning and go on till [it] come[s] to the end; then stop."
Competing interests guide partnership advisors in drafting partnership allocations. Partnership advisors must balance concerns about getting the right amount of money to the right partners against making sure that the Code's partnership rules will respect those allocations. The partnership bar is divided over whether partnership agreements should provide for liquidation in accordance with capital accounts or, instead, should liquidate by specified tiers that do not reference capital accounts.
While not attempting to answer that question, the following discussion will raise issues that partnership advisors should consider if they use "target allocations" for partnership allocations. "Target allocations" are allocations of income, gain, loss, and deduction explicitly made in a manner that adjusts the capital account balance of each partner to equal the amount that the partnership will distribute to the partner when the partnership liquidates by tiers that do not reference capital accounts.
Many will disagree with parts of the discussion that follows. Many of the issues discussed do not currently have certain resolution. The interpretations of law it proposes may not prevail when taxpayers litigate the underlying issues-or perhaps when the Treasury and the IRS promulgate future guidance. The issues, however, must be understood so clients can be properly counseled.
This is the first part of a two-part article that will examine various scenarios of target allocation from the relatively straightforward to downright elusive. It will consider partnership agreements and LLC agreements for partnerships, limited partnerships, limited liability partnerships, and limited...