1.704-1—Partner's distributive share.
(a) Effect of partnership agreement.
A partner's distributive share of any item or class of items of income, gain, loss, deduction, or credit of the partnership shall be determined by the partnership agreement, unless otherwise provided by section 704 and paragraphs (b) through (e) of this section. For definition of partnership agreement see section 761(c).
| Heading | Section |
|---|---|
| Cross-references | 1.704-1(b)(0) |
| In general | 1.704-1(b)(1) |
| Basic principles | 1.704-1(b)(1)(i) |
| Effective dates | 1.704-1(b)(1)(ii) |
| Generally | 1.704-1(b)(1)(ii)(a) |
| Foreign tax expenditures | 1.704-1(b)(1)(ii)(b) |
| Effect of other sections | 1.704-1(b)(1)(iii) |
| Other possible tax consequences | 1.704-1(b)(1)(iv) |
| Purported allocations | 1.704-1(b)(1)(v) |
| Section 704(c) determinations | 1.704-1(b)(1)(vi) |
| Bottom line allocations | 1.704-1(b)(1)(vii) |
| Substantial economic effect | 1.704-1(b)(2) |
| Two-part analysis | 1.704-1(b)(2)(i) |
| Economic effect | 1.704-1(b)(2)(ii) |
| Fundamental principles | 1.704-1(b)(2)(ii)(a) |
| Three requirements | 1.704-1(b)(2)(ii)(b) |
| Obligation to restore deficit | 1.704-1(b)(2)(ii)(c) |
| Alternate test for economic effect | 1.704-1(b)(2)(ii)(d) |
| Partial economic effect | 1.704-1(b)(2)(ii)(e) |
| Reduction of obligation to restore | 1.704-1(b)(2)(ii)(f) |
| Liquidation defined | 1.704-1(b)(2)(ii)(g) |
| Partnership agreement defined | 1.704-1(b)(2)(ii)(h) |
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| Economic effect equivalence | 1.704-1(b)(2)(ii)(i) |
| Substantiality | 1.704-1(b)(2)(iii) |
| General rules | 1.704-1(b)(2)(iii)(a) |
| Shifting tax consequences | 1.704-1(b)(2)(iii)(b) |
| Transitory allocations | 1.704-1(b)(2)(iii)(c) |
| Maintenance of capital accounts | 1.704-1(b)(2)(iv) |
| In general | 1.704-1(b)(2)(iv)(a) |
| Basic rules | 1.704-1(b)(2)(iv)(b) |
| Treatment of liabilities | 1.704-1(b)(2)(iv)(c) |
| Contributed property | 1.704-1(b)(2)(iv)(d) |
| In general | 1.704-1(b)(2)(iv)(d)(1) |
| Contribution of promissory notes | 1.704-1(b)(2)(iv)(d)(2) |
| Section 704(c) considerations | 1.704-1(b)(2)(iv)(d)(3) |
| Distributed property | 1.704-1(b)(2)(iv)(e) |
| In general | 1.704-1(b)(2)(iv)(e)(1) |
| Distribution of promissory notes | 1.704-1(b)(2)(iv)(e)(2) |
| Revaluations of property | 1.704-1(b)(2)(iv)(f) |
| Adjustments to reflect book value | 1.704-1(b)(2)(iv)(g) |
| In general | 1.704-1(b)(2)(iv)(g)(1) |
| Payables and receivables | 1.704-1(b)(2)(iv)(g)(2) |
| Determining amount of book items | 1.704-1(b)(2)(iv)(g)(3) |
| Determinations of fair market value | 1.704-1(b)(2)(iv)(h) |
| Section 705(a)(2)(B) expenditures | 1.704-1(b)(2)(iv)(i) |
| In general | 1.704-1(b)(2)(iv)(i)(1) |
| Expenses described in section 709 | 1.704-1(b)(2)(iv)(i)(2) |
| Disallowed losses | 1.704-1(b)(2)(iv)(i)(3) |
| Basis adjustments to section 38 property | 1.704-1(b)(2)(iv)(j) |
| Depletion of oil and gas properties | 1.704-1(b)(2)(iv)(k) |
| In general | 1.704-1(b)(2)(iv)(k)(1) |
| Simulated depletion | 1.704-1(b)(2)(iv)(k)(2) |
| Actual depletion | 1.704-1(b)(2)(iv)(k)(3) |
| Effect of book values | 1.704-1(b)(2)(iv)(k)(4) |
| Transfers of partnership interests | 1.704-1(b)(2)(iv)(l) |
| Section 754 elections | 1.704-1(b)(2)(iv)(m) |
| In general | 1.704-1(b)(2)(iv)(m)(1) |
| Section 743 adjustments | 1.704-1(b)(2)(iv)(m)(2) |
| Section 732 adjustments | 1.704-1(b)(2)(iv)(m)(3) |
| Section 734 adjustments | 1.704-1(b)(2) iv)(m)(4) |
| Limitations on adjustments | 1.704-1(b)(2) iv)(m)(5) |
| Partnership level characterization | 1.704-1(b)(2)(iv)(n) |
| Guaranteed payments | 1.704-1(b)(2)(iv)(o) |
| Minor discrepancies | 1.704-1(b)(2)(iv)(p) |
| Adjustments where guidance is lacking | 1.704-1(b)(2)(iv)(q) |
| Restatement of capital accounts | 1.704-1(b)(2)(iv)(r) |
| Partner's interest in the partnership | 1.704-1(b)(3) |
| In general | 1.704-1(b)(3)(i) |
| Factors considered | 1.704-1(b)(3)(ii) |
| Certain determinations | 1.704-1(b)(3)(iii) |
| Special rules | 1.704-1(b)(4) |
| Allocations to reflect revaluations | 1.704-1(b)(4)(i) |
| Credits | 1.704-1(b)(4)(ii) |
| Excess percentage depletion | 1.704-1(b)(4)(iii) |
| Allocations attributable to nonrecourse liabilities | 1.704-1(b)(4)(iv) |
| Allocations under section 613A(c(7)(D) | 1.704-1(b)(4)(v) |
| Amendments to partnership agreement | 1.704-1(b)(4)(vi) |
| Recapture | 1.704-1(b)(4)(vii) |
| Allocation of creditable foreign taxes | 1.704-1(b)(4)(viii) |
| In general | 1.704-1(b)(4)(viii)(a) |
| Creditable foreign tax expenditures (CFTEs) | 1.704-1(b)(4)(viii)(b) |
| Income to which CFTEs relate | 1.704-1(b)(4)(viii)(c) |
| In general | 1.704-1(b)(4)(viii)(c)(1) |
| CFTE category | 1.704-1(b)(4)(viii)(c)(2) |
| Net income in a CFTE category | 1.704-1(b)(4)(viii)(c)(3) |
| Distributive shares of income | 1.704-1(b)(4)(viii)(c)(4) |
| No net income in a CFTE category | 1.704-1(b)(4)(viii)(c)(5) |
| Allocation and apportionment of CFTEs to CFTE categories | 1.704-1(b)(4)(viii)(d) |
| In general | 1.704-1(b)(4)(viii)(d)(1) |
| Timing and base differences | 1.704-1(b)(4)(viii)(d)(2) |
| Special rules for inter-branch payments | 1.704-1(b)(4)(viii)(d)(3) |
| Examples | 1.704-1(b)(5) |
(1) In general—
(i) Basic principles.
Under section 704(b) if a partnership agreement does not provide for the allocation of income, gain, loss, deduction, or credit (or item thereof) to a partner, or if the partnership agreement provides for the allocation of income, gain, loss, deduction, or credit (or item thereof) to a partner but such allocation does not have substantial economic effect, then the partner's distributive share of such income, gain, loss, deduction, or credit (or item thereof) shall be determined in accordance with such partner's interest in the partnership (taking into account all facts and circumstances). If the partnership agreement provides for the allocation of income, gain, loss, deduction, or credit (or item thereof) to a partner, there are three ways in which such allocation will be respected under section 704(b) and this paragraph. First, the allocation can have substantial economic effect in accordance with paragraph (b)(2) of this section. Second, taking into account all facts and circumstances, the allocation can be in accordance with the partner's interest in the partnership. See paragraph (b)(3) of this section. Third, the allocation can be deemed to be in accordance with the partner's interest in the partnership pursuant to one of the special rules contained in paragraph (b)(4) of this section and § 1.704-2. To the extent an allocation under the partnership agreement of income, gain, loss, deduction, or credit (or item thereof) to a partner does not have substantial economic effect, is not in accordance with the partner's interest in the partnership, and is not deemed to be in accordance with the partner's interest in the partnership, such income, gain, loss, deduction, or credit (or item thereof) will be reallocated in accordance with the partner's interest in the partnership (determined under paragraph (b)(3) of this section).
(ii) Effective dates.
(a) Generally. Except as otherwise provided in this section, the provisions of this paragraph are effective for partnership taxable years beginning after December 31, 1975. However, for partnership taxable years beginning after December 31, 1975, but before May 1, 1986, (January 1, 1987, in the case of allocations of nonrecourse deductions as defined in paragraph (b)(4)(iv)(a) of this section) an allocation of income, gain, loss, deduction, or credit (or item thereof) to a partner that is not respected under this paragraph nevertheless will be respected under section 704(b) if such allocation has substantial economic effect or is in accordance with the partners' interests in the partnership as those terms have been interpreted under the relevant case law, the legislative history of section 210(d) of the Tax Reform Act of 1976, and the provisions of this paragraph in effect for partnership taxable years beginning before May 1, 1986. Paragraphs (b)(2)(iii)(a) (last sentence), (b)(2)(iii)(d ), (b)(2)(iii)(e ), and (b)(5) Example 28, Example 29, and Example 30 of this section apply to partnership taxable years beginning on or after May 19, 2008.
(b) Rules relating to foreign tax expenditures —(1) In general. The provisions of paragraphs (b)(3)(iv) and (b)(4)(viii) of this section (regarding the allocation of creditable foreign taxes) apply for partnership taxable years beginning on or after October 19, 2006. The rules that apply to allocations of creditable foreign taxes made in partnership taxable years beginning before October 19, 2006 are contained in §§ 1.704-1T(b)(1)(ii) (b )(1) and 1.704-1T(b)(4)(xi) as in effect prior to October 19, 2006 (see 26 CFR part 1 revised as of April 1, 2005). However, taxpayers may rely on the provisions of paragraphs (b)(3)(iv) and (b)(4)(viii) of this section for partnership taxable years beginning on or after April 21, 2004.
(2) Transition rule. Transition relief is provided herein to partnerships whose agreements were entered into prior to April 21, 2004. In such case, if there has been no material modification to the partnership agreement on or after April 21, 2004, then the partnership may apply the provisions of paragraph (b) of this section as if the amendments made by paragraphs (b)(3)(iv) and (b)(4)(viii) of this section had not occurred. If the partnership agreement was materially modified on or after April 21, 2004, then the rules provided in paragraphs (b)(3)(iv) and (b)(4)(viii) of this section shall apply to the later of the taxable year beginning on or after October 19, 2006 or the taxable year within which the material modification occurred, and to all subsequent taxable years. If the partnership agreement was materially modified on or after April 21, 2004, and before a tax year beginning on or after October 19, 2006, see §§ 1.704-1T(b)(1)(ii) (b )(1) and 1.704-1T(b)(4)(xi) as in effect prior to October 19, 2006 ( 26 CFR part 1 revised as of April 1, 2005). For purposes of this paragraph (b)(1)(ii)(b )(2 ), any change in ownership constitutes a material modification to the partnership agreement. This transition rule does not apply to any taxable year (and all subsequent taxable years) in which persons that are related to each other (within the meaning of section 267(b) and 707(b)) collectively have the power to amend the partnership agreement without the consent of any unrelated party.
(iii) Effect of other sections.
The determination of a partner's distributive share of income, gain, loss, deduction, or credit (or item thereof) under section 704(b) and this paragraph is not conclusive as to the tax treatment of a partner with respect to such distributive share. For example, an allocation of loss or deduction to a partner that is respected under section 704(b) and this paragraph may not be deductible by such partner if the partner lacks the requisite motive for economic gain (see, e.g., Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 1966)), or may be disallowed for that taxable year (and held in suspense) if the limitations of section 465 or section 704(d) are applicable. Similarly, an allocation that is respected under section 704(b) and this paragraph nevertheless may be reallocated under other provisions, such as section 482, section 704(e)(2), section 706(d) (and related assignment of income principles), and paragraph (b)(2)(ii) of § 1.751-1. If a partnership has a section 754 election in effect, a partner's distributive share of partnership income, gain, loss, or deduction may be affected as provided in § 1.743-1 (see paragraph (b)(2)(iv)(m )(2) of this section). A deduction that appears to be a nonrecourse deduction deemed to be in accordance with the partners' interests in the partnership may not be such because purported nonrecourse liabilities of the partnership in fact constitute equity rather than debt. The examples in paragraph (b)(5) of this section concern the validity of allocations under section 704(b) and this paragraph and, except as noted, do not address the effect of other sections or limitations on such allocations.
(iv) Other possible tax consequences.
Allocations that are respected under section 704(b) and this paragraph may give rise to other tax consequences, such as those resulting from the application of section 61, section 83, section 751, section 2501, paragraph (f) of § 1.46-3, § 1.47-6, paragraph (b)(1) of § 1.721-1 (and related principles), and paragraph (e) of § 1.752-1. The examples in paragraph (b)(5) of this section concern the validity of allocations under section 704(b) and this paragraph and, except as noted, do not address other tax consequences that may result from such allocations.
(v) Purported allocations.
Section 704(b) and this paragraph do not apply to a purported allocation if it is made to a person who is not a partner of the partnership (see section 7701(a)(2) and paragraph (d) of § 301.7701-3) or to a person who is not receiving the purported allocation in his capacity as a partner (see section 707(a) and paragraph (a) of § 1.707-1 ).
(vi) determinations.
Section 704(c) and § 1.704-3 generally require that if property is contributed by a partner to a partnership, the partners' distributive shares of income, gain, loss, and deduction, as computed for tax purposes, with respect to the property are determined so as to take account of the variation between the adjusted tax basis and fair market value of the property. Although section 704(b) does not directly determine the partners' distributive shares of tax items governed by section 704(c), the partners' distributive shares of tax items may be determined under section 704(c) and § 1.704-3 (depending on the allocation method chosen by the partnership under § 1.704-3) with reference to the partners' distributive shares of the corresponding book items, as determined under section 704(b) and this paragraph. (See paragraphs (b)(2)(iv)(d) and (b)(4)(i) of this section.) See § 1.704-3 for methods of making allocations under section 704(c), and § 1.704-3(d)(2) for a special rule in determining the amount of book items if the remedial allocation method is chosen by the partnership. See also paragraph (b)(5) Example (13) (i) of this section.
(vii) Bottom line allocations.
Section 704(b) and this paragraph are applicable to allocations of income, gain, loss, deduction, and credit, allocations of specific items of income, gain, loss, deduction, and credit, and allocations of partnership net or “bottom line” taxable income and loss. An allocation to a partner of a share of partnership net or “bottom line” taxable income or loss shall be treated as an allocation to such partner of the same share of each item of income, gain, loss, and deduction that is taken into account in computing such net or “bottom line” taxable income or loss. See example 15(i) of paragraph (b)(5) of this section.
(2) Substantial economic effect—
(i) Two-part analysis.
The determination of whether an allocation of income, gain, loss, or deduction (or item thereof) to a partner has substantial economic effect involves a two-part analysis that is made as of the end of the partnership taxable year to which the allocation relates. First, the allocation must have economic effect (within the meaning of paragraph (b)(2)(ii) of this section). Second, the economic effect of the allocation must be substantial (within the meaning of paragraph (b)(2)(iii) of this section).
(ii) Economic effect—
(a) Fundamental principles. In order for an allocation to have economic effect, it must be consistent with the underlying economic arrangement of the partners. This means that in the event there is an economic benefit or economic burden that corresponds to an allocation, the partner to whom the allocation is made must receive such economic benefit or bear such economic burden.
(b) Three requirements. Based on the principles contained in paragraph (b)(2)(ii)(a) of this section, and except as otherwise provided in this paragraph, an allocation of income, gain, loss, or deduction (or item thereof) to a partner will have economic effect if, and only if, throughout the full term of the partnership, the partnership agreement provides—
(1) For the determination and maintenance of the partners' capital accounts in accordance with the rules of paragraph (b)(2)(iv) of this section,
(2) Upon liquidation of the partnership (or any partner's interest in the partnership), liquidating distributions are required in all cases to be made in accordance with the positive capital account balances of the partners, as determined after taking into account all capital account adjustments for the partnership taxable year during which such liquidation occurs (other than those made pursuant to this requirement (2) and requirement (3) of this paragraph (b)(2)(ii)(b )), by the end of such taxable year (or, if later, within 90 days after the date of such liquidation), and
(3) If such partner has a deficit balance in his capital account following the liquidation of his interest in the partnership, as determined after taking into account all capital account adjustments for the partnership taxable year during which such liquidation occurs (other than those made pursuant to this requirement (3 )), he is unconditionally obligated to restore the amount of such deficit balance to the partnership by the end of such taxable year (or, if later, within 90 days after the date of such liquidation), which amount shall, upon liquidation of the partnership, be paid to creditors of the partnership or distributed to other partners in accordance with their positive capital account balances (in accordance with requirement (2) of this paragraph (b)(2)(ii )(b )).
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(c) Obligation to restore deficit. If a partner is not expressly obligated to restore the deficit balance in his capital account, such partner nevertheless will be treated as obligated to restore the deficit balance in his capital account (in accordance with requirement (3) of paragraph (b)(2)(ii)(b) of this section) to the extent of—
(1) The outstanding principal balance of any promissory note (of which such partner is the maker) contributed to the partnership by such partner (other than a promissory note that is readily tradable on an established securities market), and
(2) The amount of any unconditional obligation of such partner (whether imposed by the partnership agreement or by State or local law) to make subsequent contributions to the partnership (other than pursuant to a promissory note of which such partner is the maker),
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(d) Alternate test for economic effect. If—
(1) Requirements (1) and (2) of paragraph (b)(2)(ii)(b) of this section are satisfied, and
(2) The partner to whom an allocation is made is not obligated to restore the deficit balance in his capital account to the partnership (in accordance with requirement (3) of paragraph (b)(2)(ii)(b) of this section), or is obligated to restore only a limited dollar amount of such deficit balance, and
(3) The partnership agreement contains a “qualified income offset,”
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(4) Adjustments that, as of the end of such year, reasonably are expected to be made to such partner's capital account under paragraph (b)(2)(iv)(k) of this section for depletion allowances with respect to oil and gas properties of the partnership, and
(5) Allocations of loss and deduction that, as of the end of such year, reasonably are expected to be made to such partner pursuant to section 704(e)(2), section 706(d), and paragraph (b)(2)(ii) of § 751-1, and
(6) Distributions that, as of the end of such year, reasonably are expected to be made to such partner to the extent they exceed offsetting increases to such partner's capital account that reasonably are expected to occur during (or prior to) the partnership taxable years in which such distributions reasonably are expected to be made (other than increases pursuant to a minimum gain chargeback under paragraph (b)(4)(iv)(e) of this section or under § 1.704-2(f); however, increases to a partner's capital account pursuant to a minimum gain chargeback requirement are taken into account as an offset to distributions of nonrecourse liability proceeds that are reasonably expected to be made and that are allocable to an increase in partnership minimum gain).
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(e) Partial economic effect. If only a portion of an allocation made to a partner with respect to a partnership taxable year has economic effect, both the portion that has economic effect and the portion that is reallocated shall consist of a proportionate share of all items that made up the allocation to such partner for such year. See examples (15) (ii) and (iii) of paragraph (b)(5) of this section.
(f) Reduction of obligation to restore. If requirements (1) and (2) of paragraph (b)(2)(ii)(b) of this section are satisfied, a partner's obligation to restore the deficit balance in his capital account (or any limited dollar amount thereof) to the partnership may be eliminated or reduced as of the end of a partnership taxable year without affecting the validity of prior allocations (see paragraph (b)(4)(vi) of this section) to the extent the deficit balance (if any) in such partner's capital account, after reduction for the items described in (4 ), (5 ), and (6) of paragraph (b)(2)(ii)(d) of this section, will not exceed the partner's remaining obligation (if any) to restore the deficit balance in his capital account. See example (1)(viii) of paragraph (b)(5) of this section.
(g) Liquidation defined. For purposes of this paragraph, a liquidation of a partner's interest in the partnership occurs upon the earlier of (1) the date upon which there is a liquidation of the partnership, or (2) the date upon which there is a liquidation of the partner's interest in the partnership under paragraph (d) of § 1.761-1. For purposes of this paragraph, the liquidation of a partnership occurs upon the earlier of (3) the date upon which the partnership is terminated under section 708(b)(1), or (4) the date upon which the partnership ceases to be a going concern (even though it may continue in existence for the purpose of winding up its affairs, paying its debts, and distributing any remaining balance to its partners). Requirements (2) and (3) of paragraph (b)(2)(ii)(b) of this section will be considered unsatisfied if the liquidation of a partner's interest in the partnership is delayed after its primary business activities have been terminated (for example, by continuing to engage in a relatively minor amount of business activity, if such actions themselves do not cause the partnership to terminate pursuant to section 708(b)(1)) for a principal purpose of deferring any distribution pursuant to requirement (2) of paragraph (b)(2)(ii)(b) of this section or deferring any partner's obligations under requirement (3) of paragraph (b)(2)(ii)(b) of this section.
(h) Partnership agreement defined. For purposes of this paragraph, the partnership agreement includes all agreements among the partners, or between one or more partners and the partnership, concerning affairs of the partnership and responsibilities of partners, whether oral or written, and whether or not embodied in a document referred to by the partners as the partnership agreement. Thus, in determining whether distributions are required in all cases to be made in accordance with the partners' positive capital account balances (requirement (2) of paragraph (b)(2)(ii)(b) of this section), and in determining the extent to which a partner is obligated to restore a deficit balance in his capital account (requirement (3) of paragraph (b)(2)(ii)(b) of this section), all arrangements among partners, or between one or more partners and the partnership relating to the partnership, direct and indirect, including puts, options, and other buy-sell agreements, and any other “stop-loss” arrangement, are considered to be part of the partnership agreement. (Thus, for example, if one partner who assumes a liability of the partnership is indemnified by another partner for a portion of such liability, the indemnifying partner (depending upon the particular facts) may be viewed as in effect having a partial deficit makeup obligation as a result of such indemnity agreement.) In addition, the partnership agreement includes provisions of Federal, State, or local law that govern the affairs of the partnership or are considered under such law to be a part of the partnership agreement (see the last sentence of paragraph (c) of § 1.761-1 ). For purposes of this paragraph (b)(2)(ii)(h ), an agreement with a partner or a partnership shall include an agreement with a person related, within the meaning of section 267(b) (without modification by section 267(e)(1)) or section 707(b)(1), to such partner or partnership. For purposes of the preceding sentence, sections 267(b) and 707(b)(1) shall be applied for partnership taxable years beginning after December 29, 1988 by (1) substituting “80 percent or more” for “more than 50 percent” each place it appears in such sections, (2) excluding brothers and sisters from the members of a person's family, and (3) disregarding § 267(f)(1)(A).
(i) Economic effect equivalence. Allocations made to a partner that do not otherwise have economic effect under this paragraph (b)(2)(ii) shall nevertheless be deemed to have economic effect, provided that as of the end of each partnership taxable year a liquidation of the partnership at the end of such year or at the end of any future year would produce the same economic results to the partners as would occur if requirements (1 ), (2 ), and (3) of paragraph (b)(2)(ii)(b) of this section had been satisfied, regardless of the economic performance of the partnership. See examples (4)(ii) and (iii) of paragraph (b)(5) of this section.
(iii) Substantiality—
(a) General rules. Except as otherwise provided in this paragraph (b)(2)(iii), the economic effect of an allocation (or allocations) is substantial if there is a reasonable possibility that the allocation (or allocations) will affect substantially the dollar amounts to be received by the partners from the partnership, independent of tax consequences. Notwithstanding the preceding sentence, the economic effect of an allocation (or allocations) is not substantial if, at the time the allocation becomes part of the partnership agreement, (1) the after-tax economic consequences of at least one partner may, in present value terms, be enhanced compared to such consequences if the allocation (or allocations) were not contained in the partnership agreement, and (2) there is a strong likelihood that the after-tax economic consequences of no partner will, in present value terms, be substantially diminished compared to such consequences if the allocation (or allocations) were not contained in the partnership agreement. In determining the after-tax economic benefit or detriment to a partner, tax consequences that result from the interaction of the allocation with such partner's tax attributes that are unrelated to the partnership will be taken into account. See examples 5 and 9 of paragraph (b)(5) of this section. The economic effect of an allocation is not substantial in the two situations described in paragraphs (b)(2)(iii) (b) and (c) of this section. However, even if an allocation is not described therein, its economic effect may be insubstantial under the general rules stated in this paragraph (b)(2)(iii)(a ). References in this paragraph (b)(2)(iii) to allocations include capital account adjustments made pursuant to paragraph (b)(2)(iv)(k) of this section. References in this paragraph (b)(2)(iii) to a comparison to consequences arising if an allocation (or allocations) were not contained in the partnership agreement mean that the allocation (or allocations) is determined in accordance with the partners' interests in the partnership (within the meaning of paragraph (b)(3) of this section), disregarding the allocation (or allocations) being tested under this paragraph (b)(2)(iii).
(b) Shifting tax consequences. The economic effect of an allocation (or allocations) in a partnership taxable year is not substantial if, at the time the allocation (or allocations) becomes part of the partnership agreement, there is a strong likelihood that—
(1) The net increases and decreases that will be recorded in the partners' respective capital accounts for such taxable year will not differ substantially from the net increases and decreases that would be recorded in such partners' respective capital accounts for such year if the allocations were not contained in the partnership agreement, and
(2) The total tax liability of the partners (for their respective taxable years in which the allocations will be taken into account) will be less than if the allocations were not contained in the partnership agreement (taking into account tax consequences that result from the interaction of the allocation (or allocations) with partner tax attributes that are unrelated to the partnership).
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(c) Transitory allocations. If a partnership agreement provides for the possibility that one or more allocations (the “original allocation(s)”) will be largely offset by one or more other allocations (the “offsetting allocation(s)”), and, at the time the allocations become part of the partnership agreement, there is a strong likelihood that—
(1) The net increases and decreases that will be recorded in the partners' respective capital accounts for the taxable years to which the allocations relate will not differ substantially from the net increases and decreases that would be recorded in such partners' respective capital accounts for such years if the original allocation(s) and offsetting allocation(s) were not contained in the partnership agreement, and
(2) The total tax liability of the partners (for their respective taxable years in which the allocations will be taken into account) will be less than if the allocations were not contained in the partnership agreement (taking into account tax consequences that result from the interaction of the allocation (or allocations) with partner tax attributes that are unrelated to the partnership)
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