Allocation, Allocation, Allocation!

“Put numbers on the right line on a tax return!”  Frank, are you serious?  In my next life I want to be an auditor so I can write “pass due to immateriality” on my work papers.  I get flak when my allocation of income to a partner is $10 off from the fund manager’s allocation.


Speaking of allocations, Frank’s financial statements include a Statement on Partner’s Equity.  The schedule has three columns: total, general partner and limited partner.  Big Deal!  My tax return has to show each partner’s equity or capital account.  It must show the allocation of the funds income and deductions to each partner, not to various partner classes.


Allocation among the partners must meet Section 704 economic substance test (Please Frank, resist the old joke “I know Section 704, it comes before Section 705”).  Some issues that have to be dealt with:

  1. When a partner’s capital account has been increased due to unrealized gains on a security, you must allocate the subsequent realized gain to these same partners, instead of allocating to new partners who did not participate in the unrealized increase.
  2. When a partner leaves the partnership and gets cashed out, you should provide information for that partner to calculate the gain or loss on termination.  This is important to the fund since they may be able to make a step up election to increase the basis of the remaining assets.  There may also be a mandatory step down election.
  3. Some partners may receive  publicly traded securities in satisfaction of their capital account.  You have to disclose their basis in these securities and the holding period.
  4. You have to track sales by partners and the potential that “hot assets” are in the partnership that may result in ordinary income to the selling partner.
  5. You have to disclose things like withholding on foreign partners, income sourced to various States, unrelated business income for tax exempt entities, etc.


So, in the end, while Frank’s financial statements are informative, the tax allocation among partners is where the rubber hits the road.  “Put numbers on the right line on a tax return!”  Pleassssssse!


Robert Demmett


1 reply

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