Question: Mick, Maryanne and Don are general partners in a partnership that has taxable income this year. Mick has an NOL that is expiring this year while Maryanne and Don are both in a high tax bracket. Because of their tax situations, the partnership agreement calls for all income (the partnership had $175,000 of income this year) to be allocated to Mick this year. A corresponding amount of income will be allocated to Maryanne and Don over the next two years. The partnership maintains capital accounts for all the partners. The partnership agreement calls for all liquidating distributions to be paid to partners with positive capital accounts.
1. Explain the requirements that a partnership must meet for a special allocation to have economic effect?
2. What are the requirements for the economic effect to be substantial?
3. Will the original allocation of income be respected by the IRS assuming that the partnership has reported an average income of $250,000 over the five years prior to this year? Explain why or why not.
4. Will the original allocation of income be respected by the IRS assuming that the partnership has never reported net income since its inception (the partnership has always had net operating losses)? Explain why or why not.