Partnership Allocations: Assignment-of-Income Problems

• Pages: 109-122
• Author: James R. Repetti,William H. Lyons,Charlene D. Luke

109

Chapter Six

PARTNERSHIP ALLOCATIONS:

ASSIGNMENT-OF-INCOME PROBLEMS

The obligation to pay income tax is assigned to the person whose

property or ef forts generate the income, but it is not always easy to

tell who that person is, and taxpayers may attempt to direct the

assignment in order to r educe their overall tax b urden. Because

partnership tax items are generally allocable by agreement, partners

may be tempted to use the partnership struc ture to assign income—

and deductions—in a manner that reduces the tax burden for the

partners as a group. Various rules have developed to limit the ability

of partners to engage in such tax conscious behavior.

Some of the rules already examined address some aspects of the

“assignment of income” problem. For example, the substantiality

rules of the regulations under § 704(b) (discussed in Chapter 5

§ B.4.b) deal with cases in which partners attempt to allocate income

having a particular tax characteristic to the partner who will benefit

most from that characteristic. The sub stantiality rules, however,

only seek to curb allocations of favorable tax characteristics to a

partner that will not affect the amount of money the partner

ultimately derives from the partnership. In some cases, par ticularly

those involving family members, partners may be willing to allocate

both the taxable income and corresponding monetary benefit to

someone who had not earned that income . For example, partners

may w ish to make their children partners and to allocate to them

income that would normally be taxed to the p arents. Even if the

allocations result in the children getting large sums of cash, so that

the allocations have “substantial economic effect,” the allocations

should not be permitted and, as discussed herein, are not permitted.

This Chapter addresses two assignment -of-income problems

that have led to legislation: allocations of income to a donee who has

received a partnership intere st as a gift from another partner and

allocations of tax items to persons who became partners after the

economic events corresponding to the tax items have occ urred. In

addition, this Chapter discusses the applicability of the anti -abuse

regulations under § 701 and of the judicial assignment-of-income

doctrine in the partnership context. Chapter Seven will then explore

rules specifically designed to limit the ability of partners to shift

gains and losses built into assets to other partners.