ExpertHard1 markMultiple Choice
CPA · Question 55 · Area III: Entity Tax Planning
A partnership agreement allocates 10% of income to Partner A. However, the partnership agreement states that if the partnership has a loss, 100% of the loss is allocated to Partner A. Partner A has a deficit capital account restoration obligation. Does this allocation have substantial economic effect?
A partnership agreement allocates 10% of income to Partner A. However, the partnership agreement states that if the partnership has a loss, 100% of the loss is allocated to Partner A. Partner A has a deficit capital account restoration obligation. Does this allocation have substantial economic effect?
Answer options:
A.
No, because allocations must be consistent (10% income / 10% loss).
B.
Yes, because Partner A bears the economic burden of the loss.
C.
No, because it lacks substantiality.
D.
Yes, but only if Partner A is a general partner.
How to approach this question
Economic Effect Test: 1. Capital accounts maintained? 2. Liquidation follows capital accounts? 3. Deficit restoration? If yes to all, the allocation is valid.
Full Answer
B.Yes, because Partner A bears the economic burden of the loss.✓ Correct
IRC §704(b). An allocation has economic effect if the partner to whom the allocation is made actually bears the economic burden of the loss. A deficit restoration obligation (DRO) is key to meeting this test.
Common mistakes
Thinking allocations must always match ownership percentages.
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