Learn to recognize the provisions necessary in an LLC or partnership agreement to sustain special allocations of income or loss. Partnerships and LLCs are subject to highly specialized rules regarding the allocation of gain, loss, depreciation and other tax attributes associated with contributed property. Complex rules also apply to the allocation of recourse and non-recourse liabilities. When a partner or LLC member decides to withdraw some or all of his/her capital investment in the entity, the tax consequences can be complex. Move your working knowledge of partnership and LLC taxation beyond the basics.
Objectives:Prerequisite: Completion of the AICPA course Taxation of LLCs, LLPs, LPs and Other Partnerships or equivalent knowledge and experience
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• Analyze a partnership or LLC agreement to determine whether special allocations called for in that agreement will be allowable under the §704(b) regulations, and when they will not be recognized by the IRS;Introduction
• Understand the potential economic consequences to a partner or LLC member of a special allocation;
• Recognize the sections of a partnership agreement that must exist in order for a special allocation to be valid;
• Understand the potential tax consequences when a partner or LLC member has a negative balance in his/her capital account;
• Recognize the relationship between partnership and LLC allocations of profit and loss and the allocation of the risks and rewards of entity operations; and
• Distinguish between the requirements for “substantiality” and those for “economic effect” under the regulations and understand the importance of future expectations when determining whether a proposed allocation will be both appropriate to achieve the economic objectives of the partner/members and legitimate under the §704(b) regulations.
1. The partnership/LLC agreement must provide for the proper determination and maintenance of partner/member capital accounts throughout the life of the entity;The third requirement above assures that sufficient funds will be available to the partnership/LLC to repay its creditors and to liquidate the interests of those partner/members with remaining positive capital balances.
2. The agreement must provide that upon liquidation of either the entity, or of an individual investor’s interest, liquidating distributions must be made in accordance with the positive capital balances of the investors; and
3. The agreement must require investors with negative balances in their capital accounts at liquidation to restore the deficits in those accounts.
• Cash contributions (including increases in the partner/members’ shares of partnership/LLC liabilities);4Capital accounts must be decreased by
• The fair market value of property contributed to the partnership or LLC by the partner/members (net of liabilities assumed by the partnership/LLC); and
• Allocated items of book income and gain as determined under §704(b) and the regulations thereunder, including non-taxable income and gain.
• Distributions of cash from the partnership/LLC to a partner/member (including partner/member liabilities assumed by the entity, but not including guaranteed payments made to the partner/member by the partnership/LLC);
• The fair market value of any property distributed to a partner/member (net of liabilities assumed by the distributee in connection with the distribution);
• Allocated expenditures that are not deductible in computing partnership/LLC income under Sections 702 or 703 and are not properly chargeable to capital (e.g., syndication costs, expenses incurred in generating tax-exempt income, etc.); and
• Allocated items of book loss and deduction as determined under §704(b) and the regulations thereunder, including “simulated” oil and gas depletion.5
1 Special allocations should be clearly spelled out in the partnership or LLC agreement.
2 Further restraints have been laid out by the courts with respect to family partnerships. Allocations in family
partnerships are governed by section 704(e).
3 Reg. §1.704-1(b)(2)(ii)(b).
4 Reg. § 1.704-1(b)(2)(iv)(c).
5 Reg. §1.704-1(b)(2)(iv)(b).
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