Calvin H. Johnson (Texas), Partnership Allocations From Nickel-on-the-Dollar Substance, 134 Tax Notes 873 (Feb. 13, 2012):

Current law allows allocation of partnership income to a partner if the allocation has consequences at liquidation of the partnership. For liquidations that are far away, the present value impact of liquidation is modest, typically a nickel per dollar of allocation. Nickel on the dollar impact is a pretense of economic substance. Deductions can be sold to highest bidder and revenue can be absorbed by tax indifferent partner with only a pretense of economic substance.

The proposal would require partnership deductions and accumulated income to be allocated among partners in proportion to their capital accounts. Proportionate allocation makes the partnership consistent with 100% ownership. A partnership that does not maintain proper capital accounts would allocate deductions and accumulated income according to a partner’s interests in the partnership, defined by net present value of the interest. A partner’s share of partnership debt would similarly require the partner to share both the principal payment of the debt and the interest burden. Income distributed during the tax year or shortly thereafter would be taxed by allocation of partnership income to the partner who received the distribution. Distributions not pro rata to capital accounts or partnership interest would not be considered attributable to capital and could not, for example, be considered capital gain or tax-exempt income. An anti-abuse rule would also be applied for large deductions that vary materially from reduction in net present value change to the partnership interest and for allocations of taxable income that are materially in excess of the present value increase the partner gets.

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