Special Allocation of Tax Benefits and Partnerships
| Publication year | 1978 |
| Pages | 1607 |
1978, September, Pg. 1607. Special Allocation of Tax Benefits and Partnerships
The Internal Revenue Code of 1954 introduced the provisions of "Subchapter K," which deals with the federal income taxation of partnerships. This portion of the Internal Revenue Code sought to introduce some form of order to what had previously been relative chaos with regard to the federal taxation of this frequently used business entity. The 1954 Code established the basic rule which provided that the partnership itself would not be a taxable entity, but that the tax ramifications generated by the partnership would flow through, normally on a pro-rata basis, to the individual partners and be reflected on their individual income tax returns. This is a basic adoption of the theory that the partnership consists of an "aggregate" of its member partners rather than an independent tax "entity."
Section 704 of Subchapter K set forth the rules for determining how the "pass through" of the partnership's tax attributes is to be made to the individual partners. The basic rule is that the partner's distributive share of income, gain, loss, deduction or credit, absent a contrary provision of the partnership agreement, would be determined in accordance with the provisions of the partnership agreement for the division of general profits and losses. Section 704(b) went on to provide, however, that if the partnership agreement made a different allocation of any such item of income, gain, loss, deduction or credit, that the partnership agreement would generally control.
Despite certain limitations contained in the Section 704 regulation(fn1) with regard to "tax avoidance motives" as to a "special allocation" of such items in the partnership agreement, the apparent concession of the Internal Revenue Code to recognize special allocations of tax benefits made in the partnership agreement gave rise to an extremely frequent use of such allocations in an effort to shift the tax ramifications and attributes of a partnership between and among the various partners. Such special allocations of tax benefits have become particularly popular in the case of "tax shelters" involving real estate (in which the depreciation allowable on the realty was often allocated to the limited partners) and oil
By utilizing special allocations of tax benefits, which purport to allow the investors (who are often in high tax brackets) to take advantage of tax deductions or losses in a ratio different than the actual flow of the cash or net proceeds from the partnership, the promoters of the various tax shelters were able to provide an extra incentive for investment in their programs. The utilization of special...
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