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:

No, because allocations must be consistent (10% income / 10% loss).

Yes, because Partner A bears the economic burden of the loss.

No, because it lacks substantiality.

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

Yes, because Partner A bears the economic burden of the loss.

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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