Question

Which of the following special allocations lack economic effect?

a- allocating a partner 70% of the book and taxable income when the partner owns only 40% of the capital
b- allocating a partner 30% of the book and 50% of the taxable income when the partner owns 40% of the capital
c- allocating 100% of an operating loss (for both book and tax purposes) to a general partner who owns 60% of the capital; the allocation results in a deficit in the partner's capital account and the partnership agreement does not include a qualified income oifset
d- allocating 80% of an operating loss (for both book and tax purposes) to a limited partner who swns 60% of the capital; the allocation does not result in a deficit in the partner's capital account

Answer 1

Special allocations in a partnership lack economic effect if they result in a deficit balance in a partner's capital account, violating the substantial economic effect requirement. Allocating a partner 70% of the book and taxable income when the partner owns only 40% of the capital does not lack economic effect as long as there are other factors justifying the higher allocation. Allocating 80% of an operating loss to a limited partner who owns 60% of the capital without resulting in a deficit in the partner's capital account also does not lack economic effect.

Step-by-step explanation:

None of the special allocations described lack economic effect as long as they comply with the IRS guidelines for partnership allocations. Economic effect requires that the allocations have substantial economic effect on the partners' capital accounts and that the partners bear the economic risk of loss associated with the allocations

a- Allocating a partner 70% of the book and taxable income when the partner owns only 40% of the capital does not lack economic effect. The partner may have made a larger contribution to the business other than capital, such as skills or services, which justifies the higher allocation.

b- Allocating a partner 30% of the book and 50% of the taxable income when the partner owns 40% of the capital also does not lack economic effect. The partnership agreement may have specific provisions for the different allocations based on the partner's contribution or role in the business.

c- Allocating 100% of an operating loss (for both book and tax purposes) to a general partner who owns 60% of the capital and results in a deficit in the partner's capital account does lack economic effect. This allocation violates the substantial economic effect requirement as it creates a deficit balance in the partner's capital account, which does not accurately represent the partner's economic risk of loss.

d- Allocating 80% of an operating loss (for both book and tax purposes) to a limited partner who owns 60% of the capital without resulting in a deficit in the partner's capital account does not lack economic effect. The allocation complies with the substantial economic effect requirement as it accurately reflects the partner's economic risk of loss while still maintaining a positive capital account balance.