William G. Cavanagh (Chadbourne & Parke, New York) has published Targeted Allocations Hit the Spot, 129 Tax Notes 89 (Oct. 4, 2010). Here is the abstract:

Cavanagh analyzes the economic effect prong of the substantial economic effect test applicable to partnership allocations and discusses traditional allocations as well as targeted and tracking allocations. He describes the function of some of the standard tax boilerplate provisions and suggests that those provisions be included as an appendix to partnership agreements rather than incorporated into the text of agreements.

The author compares the traditional ‘‘liquidate in accordance with capital accounts’’ allocation provisions with targeted and tracking allocation provisions that, although not explicitly sanctioned by the regulations, are nonetheless favored by many tax practitioners. He argues that the targeted/tracking allocation ‘‘tax follows cash’’ model is far superior to the traditional allocation ‘‘cash follows tax’’ model, and he recommends that the IRS provide guidance (regulations or rulings) indicating that targeted and tracking allocations will satisfy the economic effect or alternative economic effect tests.

Cavanagh also recommends that the IRS modify applicable rules to help tax practitioners avoid mistakes in drafting partnership tax allocation provisions, including confirming that the equivalent economic effect test applies to partnerships with qualified income offset provisions; permitting taxpayers to rely on the value-equals-basis rule in determining a partner’s interest in the partnership; providing in the regulations that qualified income offset, minimum gain charge-back, and partner nonrecourse debt minimum gain charge-back provisions are automatically incorporated into partnership agreements; and providing in the regulations that minimum gain charge-backs automatically carve out any gain that duplicates profits already allocated to the partner.

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