PRICKLIEST PROVISIONS IN A
PARTNERSHIP AGREEMENT:
ALLOCATIONS
APPROACHES TO ALLOCATIONS IN
PARTNERSHIP AGREEMENTS AND THEIR
IMPLICATIONS
Jennifer H. Alexander
Deloitte Tax LLP
Washington, DC
Noel P. Brock
West Virginia University
Jim Tod
KPMG LLP
San Francisco, CA
Basic Allocation Concepts
2
Overview of Operating Partnership
Agreements - Distributive Share

Section 704(a) – determined by partnership agreement

Section 704(b) – determined in accordance with partner’s interest
in a partnership (“PIP”) if:
 The partnership agreement does not provide partners’ distributive
shares, or
 Allocations in the partnership agreement lack substantial
economic effect (“SEE”)
3
Partnership Agreement Provisions Allocations and Distributions
o
Allocation Driven
 Upon liquidation, distributions are made to the partners based on
their capital account balances
 Referred to as “allocation driven” because the allocations determine
the capital accounts, which ultimately determine the economics
 Sometimes referred to as “layer cake” allocations because there is
often a waterfall – with multiple layers – in the allocation provisions
o
Distribution Driven
 Distributions are not based on capital accounts
 Referred to as “distribution driven” because the allocations do not
drive the economics
 Therefore, partnership items must be allocated in such a way that
they track the economics – i.e., the distributions drive the allocations
4
Partnership Agreement Provisions Allocations and Distributions
o
Examples of Allocation Driven Agreements
 Safe Harbor Agreements
o Agreements satisfying the test for “economic effect”
o Agreements satisfying the “alternate test for economic effect”
 Non-Safe Harbor Agreements That Liquidate by Capital Accounts
o Agreements that allocate income and loss on a non-section 704(b)
basis – for example, agreements that allocate GAAP income and
loss, or both realized and unrealized income and loss, determined
on a FMV basis
o
Examples of Distribution Driven Agreements
 Targeted allocation agreements
 Any other agreement that does not provide for liquidation by capital
accounts
5
Layered and Targeted Allocations –
The Formulae
Layered allocations compute ending capital under the following formula:
beginning
capital
+
-
contributions
distributions
+
-
income
loss
=
ending
capital
Targeted allocations plug income under the following formula:
target
ending
capital
-
beginning
capital
+
-
income
contributions
distributions
=
or
loss
6
Allocations and Distributions - Pros and Cons
Allocation Driven (Safe Harbor)
 Advantages
o Safe harbor, Treas. Reg. § 1.704-1(b)(2)
o Fractions rule, § 514(c)(9)(E)
o Allocations of nonrecourse deductions, Treas. Reg. § 1.704-2(b)(1)
o Allocations of nonrecourse liabilities, Treas. Reg. § 1.752-2(a)
 Disadvantages
o Complex to draft properly
o If wrong, interferes with deal economics
o Distribution Driven
o
Advantages
o Easier to understand the economic deal
o Easier to draft properly
 Disadvantages
o May produce unexpected tax results leaving allocations to
accountants to determine with knowledge that they are often wrong
o Allocations may be challenged

7
Substantiality & Economic Effect
Economic Effect
 Safe harbor - Treas. Reg. § 1.704-1(b)(2)(ii)(b)
 Maintenance of capital accounts under Treas. Reg. § 1.704-1(b)(2)(iv)
 Liquidation of partner’s interest in accordance with positive capital
account balances
 Deficit Restoration Obligation (“DRO”) or Qualified Income Offset
(“QIO”)

Economic Effect Equivalence
 Treas. Reg. § 1.704-1(b)(2)(ii)(i)
 Allocations are deemed to have economic effect if, at the end of each
year, a liquidation would produce the same economic effect as if the
safe harbor had been satisfied, regardless of the economic
performance of the partnership
8
Substantiality & Economic Effect
Substantiality
 Must be a reasonable possibility that the allocation will affect
substantially the dollar amounts to be received from the partnership,
independent of tax consequences.

An allocation is not substantial if:
 Overall tax effect for any partner is substantially diminished over the
life of the partnership
 There are shifting tax consequences
 There transitory allocations
9
Partner’s Interest in the Partnership (“PIP”)
If allocation fails to satisfy SEE safe harbor, partners’ distributive shares of
partnership items determined in accordance with PIP.

PIP signifies the manner in which the partners have agreed to share the
economic benefit or burden (if any) corresponding to the item being
allocated. Reg. § 1.704-1(b)(3).

Takes into account all the facts and circumstances relating to the
economic arrangement of the partners

Factors include:
Relative contributions to the partnership
 Interest in economic profits and losses
 Interest in cash flow and other non-liquidating distributions
 Rights of partners to distributions of capital on liquidation

10
Targeted Allocations– Illustrative
Examples
11
Targeted Allocations with a
Preferred Return – Example 1A
Facts:

X, Y, and Z each contribute $100 to LLC

LLC liquidates based on the following distribution provisions:
First to X until X receives a return of its contributed capital
 Second to X, a 10% simple return on X’s unreturned capital
 Third to Y and Z, their unreturned capital
 Fourth 1/3 each to X, Y, and Z


LLC had the following items of income/loss for the year:
Gross Revenue of $100
 Expenses of $150
 Unrealized Asset Appreciation of $90

12
Targeted Allocations –
Sample Language
Except as otherwise provided in [THE REGULATORY ALLOCATIONS
PROVISION], and after adjusting for all capital contributions and
distributions made during such tax year, Net Income and Net Loss (and, if
necessary, individual items of gross income or loss) shall be
allocated annually (and at such other times in which it is necessary to
allocate Net Income or Net Loss), the Company shall allocate all of its Net
Profit and Net Loss for such tax year in a manner such that, after such
allocations have been made, the balance of each Member’s Capital Account
shall, to the extent possible, be equal to an amount that would be distributed
to such Member if (a) the Company were to sell the assets of the Company
for their Book Values, (b) all Company liabilities were satisfied (limited with
respect to each nonrecourse liability to the Book Values of the assets
securing such liability), (c) the Company were to distribute the proceeds of
sale pursuant to [THE DISTRIBUTION PROVISION] and (d) the Company
were to dissolve pursuant to [THE LIQUIDATION PROVISION], minus the
sum of (1) such Member’s share of Minimum Gain or Member Minimum
Gain, and (2) the amount, if any, that such Member is obligated (or deemed
obligated) to contribute, in its capacity as a Member, to the Company;
computed immediately prior to the hypothetical sale of assets.
13
Targeted Allocations –
Sample Language (cont.)
o The LLC Agreement’s definition of “Net Income” and “Net Loss” reads as
follows:
“Net Income” and “Net Loss” means, for purposes of this Agreement, for
each Fiscal Year or other period, an amount equal to the Company’s
taxable income or loss for such year or period, determined in
accordance with Code § 703(a) (for this purpose, all items of income,
gain, loss, or deduction required to be stated separately pursuant to Code
§ 703(a)(1) shall be included in taxable income or loss), [...]
14
Targeted Allocations with a
Preferred Return – Example 1A
Step 1.
Determine Beginning Capital
Step 2.
Determine Contributions/Distributions
Step 3.
Adjusted Capital
Step 4.
Determine Aggregate Capital
Step 5.
Determine Ending Capital
First – Return X Capital
Second – Return X 10% Return
Third – Return Y and Z Capital
Fourth – Return Remainder Pro-Rata
Total Ending Capital
Step 6.
Allocate Income to Match Ending
(subtract Step 3 from Step 5)
X
Y
Z
Total
100
100
100
300
0
0
0
0
100
100
100
300
250
100
10
0
110
70
0
70
70
0
100
10
140
0
70
250
10
(30)
(30)
(50)
15
Targeted Allocations with a
Preferred Return – Example 1B
Facts:

Same facts as Example 1A, except:

LLC Agreement calls for allocations of “Net Income or Net Loss” and
does not include “(and, if necessary, individual items of gross income
or loss)”
16
Targeted Allocations with a
Preferred Return – Example 1B
Step 1.
Determine Beginning Capital
Step 2.
Determine Contributions/Distributions
Step 3.
Adjusted Capital
Step 4.
Determine Aggregate Capital
Step 5.
Determine Ending Capital
First – Return X Capital
Second – Return X 10% Return
Third – Return Y and Z Capital
Fourth – Return Remainder Pro-Rata
Total Ending Capital
Step 6.
X
Y
Z
Total
100
100
100
300
0
0
0
0
100
100
100
300
250
100
10
0
110
70
0
70
70
0
100
10
140
0
70
250
Allocate Income
?
?
?
?
17
Various Approaches
X
Gross Allocation Approach:
Y
Z
Total
10
(30)
(30)
(50)
10
(30)
(30)
(50)
10?
(30)?
(30)?
(50)
0
(25)
(25)
(50)
10
(30)
(30)
(50)
0
(25)
(25)
(50)
(25) (12.5) (12.5)
(50)
Net Allocation Approach:
o Guaranteed Payment
o Capital Shift
o Taxable
o Non-Taxable
PIP using Section 704(b) Value:
PIP accounting for Built-in-Gain:
PIP using Fair Market Value:
18
Targeted Allocations with a Preferred
Return – Guaranteed Payment
X
Y
Z
Total
Step 1.
Step 2.
Determine Beginning Capital
Determine Contributions/Distributions
100
0
100
0
100
0
300
0
Step 3.
Adjusted Capital
100
100
100
300
Step 4.
Determine Aggregate Capital
Step 5.
Determine Ending Capital
First – Return X Capital
Second – Return X 10% Return
Third – Return Y and Z Capital
Fourth – Return Remainder Pro-Rata
Total Ending Capital
Step 6.
Step 7.
Beginning Capital
Guaranteed Payment (OI/OD)
Allocate Income to Match Ending
Ending Capital
250
100
100
10
70
70
10
140
0
0
0
0
110
70
70
250
100
10
100
(5)
(25)
100
(5)
(25)
(50)
70
70
240?
100?
19
Targeted Allocations with a Preferred
Return – Taxable Capital Shift
X
Y
Z
Total
Step 1.
Step 2.
Determine Beginning Capital
Determine Contributions/Distributions
100
0
100
0
100
0
300
0
Step 3.
Adjusted Capital
100
100
100
300
Step 4.
Determine Aggregate Capital
Step 5.
Determine Ending Capital
First – Return X Capital
Second – Return X 10% Return
Third – Return Y and Z Capital
Fourth – Return Remainder Pro-Rata
Total Ending Capital
Step 6.
Step 7.
Step 8.
Beginning Capital
Capital Shift
250
100
100
10
70
70
10
140
0
0
0
0
110
70
70
250
100
10
100
(5)
(25)
100
(5)
(25)
(50)
250
Allocate Income to Match Ending
Ending Capital
110
70
70
Taxable Income/Deduction
10?
(5)?
(5)?
20
Targeted Allocations with a Preferred
Return – Non-Taxable Capital Shift
X
Y
Z
Total
Step 1.
Step 2.
Determine Beginning Capital
Determine Contributions/Distributions
100
0
100
0
100
0
300
0
Step 3.
Adjusted Capital
100
100
100
300
Step 4.
Determine Aggregate Capital
Step 5.
Determine Ending Capital
First – Return X Capital
Second – Return X 10% Return
Third – Return Y and Z Capital
Fourth – Return Remainder Pro-Rata
Total Ending Capital
Step 6.
Step 7.
Step 8.
Beginning Capital
Capital Shift
Allocate Income to Match Ending
Ending Capital
Taxable Income/Deduction
250
100
100
10
70
70
10
140
0
0
0
0
110
70
70
250
100
10
100
(5)
(25)
100
(5)
(25)
(50)
110
70
70
250
0
0
0
21
Targeted Allocations with a Preferred
Return – PIP Using 704(b)
X
Y
Z
Total
Step 1.
Step 2.
Determine Beginning Capital
Determine Contributions/Distributions
100
0
100
0
100
0
300
0
Step 3.
Adjusted Capital
100
100
100
300
Step 4.
Determine Aggregate Capital
Step 5.
Determine Ending Capital
First – Return X Capital
Second – Return X 10% Return
Third – Return Y and Z Capital
Fourth – Return Remainder Pro-Rata
Total Ending Capital
Step 7.
Beginning Capital
Allocate Gross Items to Match Ending
Ending Capital
250
100
100
10
70
70
10
140
0
0
0
0
110
70
70
250
100
100
100
10
(30)
70
(30)
70
110
(50)
250
22
Targeted Allocations with a Preferred
Return – PIP Accounting for BIG
X
Y
Z
Total
Step 1.
Step 2.
Determine Beginning Capital
Determine Contributions/Distributions
100
0
100
0
100
0
300
0
Step 3.
Adjusted Capital
100
100
100
300
Step 4.
Determine Aggregate Capital
Step 5.
Determine Ending Capital
First – Return X Capital
Second – Return X 10% Return
Third – Return Y and Z Capital
Fourth – Return Remainder Pro-Rata
Total Ending Capital
Step 6.
Step 7.
Beginning Capital
Allocate Income
Ending Capital
Hypothetical Allocation of MTM Gain
Hypothetical Ending Capital
340
100
100
10
100
100
10
200
10
10
10
30
120
110
110
340
100
100
100
(25)
75
100
(25)
75
(50)
250
20
35
35
120
110
110
90
340
23
Targeted Allocations with a Preferred
Return – PIP Using FMV
X
Y
Z
Total
Step 1.
Step 2.
Determine Beginning Capital
Determine Contributions/Distributions
100
0
100
0
100
0
300
0
Step 3.
Adjusted Capital
100
100
100
300
Step 4.
Determine Aggregate Capital
Step 5.
Determine Ending Capital
First – Return X Capital
Second – Return X 10% Return
Third – Return Y and Z Capital
Fourth – Return Remainder Pro-Rata
Total Ending Capital
Step 6.
Step 7.
Beginning Capital
Allocate Income
Ending Capital
Hypothetical Allocation of MTM Gain
Hypothetical Ending Capital
340
100
100
10
100
100
10
200
10
10
10
30
120
110
110
340
100
(12.5)
87.5
100
(12.5)
87.5
(50)
250
45
22.5
22.5
120
110
110
100
(25)
75
90
340
24
Who is the “Preparer” of Partnership
Allocations?
25
Preparer of Allocations for Tax Purposes
Section 6694 – Tax Return Preparer Penalties
 Penalizes income tax return preparers for understatements of taxpayer’s
liability which result from negligent disregard of rules and regulations
by the return preparer or from willful attempts by the return preparer to
understate the tax due.
 One purpose of the return preparer penalty rules was to ensure that the
person who makes the decisions and calculations involved in preparing
a particular return will be considered the preparer of that return, even if
that person “does not actually place the figures on the lines of the
taxpayer’s final tax return.” H.R. Rep. No. 94-658, 2d Sess. 275,
reprinted in 1976 U.S.C.C.A.N. 3171.
 Treas. Reg. § 1.6694-2(e)(6) – one of the relevant factors to be
considered in determining whether the penalty will be imposed is
whether the preparer “reasonably relied in good faith on generally
accepted administrative or industry practice in taking the position that
resulted in the understatement.”
26
Preparer of Allocations for Tax Purposes
Section 7701(a)(36)(A) “Tax Return Preparer”
 “means any person who prepares for compensation, or who
employs one or more persons to prepare for compensation, any
return of tax imposed by this title or any claim for refund of tax
imposed by this title. For purposes of the preceding sentence, the
preparation of a substantial portion of a return or a claim for
refund shall be treated as if it were the preparation of such
return or claim for refund.” (Emphasis added)
 Elements:
Prepares for compensation (or employs others to prepare); and
 Return of tax imposed by this title (or claim for refund). (For this
purpose preparation of a substantial portion of a return or claim for
refund constitutes preparation of a return.)

27
Preparer of Allocations for Tax Purposes
Section 7701(a)(36)(B) Exceptions
 A person shall not be a “tax return preparer” merely because such
person—
Furnishes typing, reproducing, or other mechanical assistance,
 Prepares a return or claim for refund of the employer by whom s/he
is regularly and continuously employed,
 Prepares as a fiduciary a return or claim for refund for any person,
 Prepares a claim for refund a taxpayer in response to any notice of
deficiency issued to such taxpayer or in response to any waiver of
restriction after the commencement of an audit of such taxpayer or
another taxpayer if a determination in such audit of such other
taxpayer directly or indirectly affects the tax liability of such taxpayer.

28
Preparer of Allocations for Tax Purposes
Treas. Reg. § 301.7701-15(a) “Tax Return Preparer”
 “A tax return preparer is any person who prepares for
compensation, or who employs one or more persons to prepare
for compensation, all or a substantial portion of any return of
tax or any claim for refund of tax under the Internal Revenue
Code (Code).” (Emphasis added)
29
Preparer of Allocations for Tax Purposes
Treas. Reg. § 301.7701-15(b)(1) “Signing Tax Return
Preparer”
 “[T]he individual tax return preparer who has the primary
responsibility for the overall substantive accuracy of the
preparation of such return or claim for refund.”
30
Preparer of Allocations for Tax Purposes
Treas. Reg. § 301.7701-15(b)(2) “Nonsigning Tax Return
Preparer”
 “[A]ny tax return preparer who is not a signing tax return
preparer but who prepares all or a substantial portion of a return
or claim for refund . . . with respect to events that have occurred
at the time the advice is rendered.”

Is the drafter of a partnership agreement a nonsigning preparer
of the partnership tax return?

Is the answer different if the allocations are safe-harbor (layercake) versus targeted?
31
Preparer of Allocations for Tax Purposes
Treas. Reg. § 301.7701-15(b)(2) “Nonsigning Tax Return
Preparer”
 Factors to help identify nonsigning tax return preparer:
Time spent on the advice given after events have occurred.
 Time spent prior to events occurring relevant if (1) facts and
circumstances show the position(s) giving rise to an understatement
is (are) primarily attributable to the advice, (2) the advice was
substantially given before events occurred primarily to avoid treating
the person giving the advice as a tax return preparer, and (3) the
advice given before events occurred was confirmed after events had
occurred for purposes of preparing a tax return.” (Emphasis added)

32
Preparer of Allocations for Tax Purposes
Treas. Reg. § 301.7701-15(b)(2) “Nonsigning Tax Return
Preparer”
 Examples:
Example 1 – an attorney in a law firm providing legal advice to a
corporate taxpayer regarding a completed corporate transaction is
considered a nonsigning tax return preparer.
 Example 2 – an attorney in a law firm providing legal advice to a
corporate taxpayer regarding the tax consequences of a contemplated
transaction, but who does not render any advice after the transaction
is completed, is not considered a tax return preparer.
 Example 3 – facts are the same as Example 2, except that the attorney
provides supplemental legal advice to the corporate taxpayer on a
phone call after the transaction is completed. The time spent on the
supplemental advice represents less than 5% of the aggregate amount
of time the attorney spent providing tax advice. Not considered a tax
return preparer.

33
Preparer of Allocations for Tax Purposes
Treas. Reg. § 301.7701-15(b)(3)(i) “Substantial Portion”
 “A person who renders tax advice on a position that is directly
relevant to the determination of the existence, characterization,
or amount of an entry on a return or a claim for a refund will be
regarded as having prepared that entry.”
 “Whether a schedule, entry, or other portion of a return . . . is a
substantial portion is determined based upon whether the person
knows or reasonably should know that the tax attributable to the
schedule, entry, or other portion of a return . . . is a substantial
portion of the tax required to be shown on the return or claim for
refund.” (Emphasis added)
 “A single entry may constitute a substantial portion of the tax
required to be shown on a return.”
34
Preparer of Allocations for Tax Purposes
Treas. Reg. § 301.7701-15(b)(3)(ii) “Substantial Portion”

De minimis exceptions:
 A schedule, entry or other portion of a return or claim for refund is
NOT considered to be a substantial portion if the schedule, entry, or
other portion of the return or claim for refund involves amounts of
gross income, amounts of deductions, or amounts on the basis of
which credits are determined that are—
 Less than $10,000; OR
 Less than $400,000 AND ALSO less than 20 percent of the gross
income as shown on the return or claim for refund.

Partnership allocations impact 100% of income as shown on the
return.
35
Preparer of Allocations for Tax Purposes
Treas. Reg. § 301.7701-15(b)(3)(iii) “Substantial Portion” - Preparer of Partner Returns?
 A tax return preparer with respect to one return may be
considered to be a tax return preparer with respect to another
return if the entry(ies) on the first return are directly reflected on
the other return and constitute a substantial portion of the other
return.

Example – the sole preparer of a partnership return of income is
considered a tax return preparer of a partner’s return if the entry(ies)
on the partnership return reportable on the partner’s return
constitute a substantial portion of the partner’s return.
36
Preparer of Allocations for Tax Purposes
Who is the Preparer of Partnership Allocations?
 The drafter of the allocations?
 The person who follows the agreement and puts the numbers on
the form(s)?
 Both?
 Is the answer different for Safe-harbor versus Targeted
Allocations?
Does drafting partnership safe-harbor allocations constitute the
“preparation” of the allocations?
 Does drafting partnership targeted allocations constitute the
“preparation” of the allocations?
 If the answers are different for safe-harbor versus targeted
allocations, what does that tell us about targeted allocations?
 Are targeted allocation provisions really allocations or are they simply
a directive to someone to draft/prepare allocations?

37
Preparer of Allocations for Tax Purposes
Who is the Preparer of Partnership Allocations?
 United States v. Pugh, 717 F. Supp. 2d 271 (E.D. NY 2010) –
holding as a preparer someone who did not actually sign the tax
return, but who rendered advice on a position that appeared in
the tax return.
 Rev. Rul. 81-270, 1981-2 C.B. 250 and GCM 38746 (June 5, 1981)
– GP who prepared partnership return for compensation held
subject to preparer penalty where limited partner found to have a
substantial understatement arising from GP’s negligence or
intentional disregard of the rules and regulations in preparing
entries on Schedule K-1. (GP did not prepare the limited
partner’s return.)
38
Preparer of Allocations for Tax Purposes
Who is the Preparer of Partnership Allocations?
 Adler v. US, 9 F.3d 617 (7th Cir. 1993), rev’g F. Supp. 579 (N.D. Ill.
1992) – suggesting accountants who prepared a partnership
return may be “preparers” of each partner’s return if the income
or loss reported to each partner constitutes a “substantial
portion” of a partner’s tax return and remanding for further
consideration by the District Court.
 Adler v. US, No. 88 C 10051 (1989) (on remand from 7th Circuit)
– accountants who prepared a partnership tax return were
“preparers” of a substantial portion of the partners’ tax returns
and, therefore, presumably were “preparers” of the individual
partners’ tax returns.
 Goulding v. US, 957 F.2d 1420 (7th Cir. 1992) – an attorney who
prepared a partnership’s return was held to be the preparer of
each partner’s return.
39
Contributors to This
Presentation

Deloitte Tax LLP – Washington National Tax,
Passthroughs

Noel P. Brock – West Virginia University

Jim Tod, KPMG LLP
40
APPENDIX
The Difference between Layered and
Targeted Allocations
Layered Allocations
What are they?
 Establish an ordering (or layers) for allocating partnership profit and
losses after considering regulatory allocations.

Generally, profits are allocated first to offset prior years’ losses that
eliminated the partners’ contributed capital and undistributed profits
that were reflected in their capital accounts at the time such losses were
allocated, and finally to reflect the manner in which the profits would be
distributed if the partnership had cash available to distribute.

Losses are generally allocated in the reverse order of profits.

Liquidating distributions generally will be made in accordance with
positive capital account balances.

Allocating profits to “fill-up” waterfall layers
Layered Allocations
Common Issues/Considerations
 Often the waterfall provisions are in the distribution section of the
agreement.

There may be a different ways of sharing profits versus sharing losses.

The allocations may be tied to target capital accounts even though they
are layered allocations.
Targeted Allocations
What are they?
 Specifies how cash will be distributed from operations and in
liquidation of the partnership.

Allocates profit/loss so that at the end of the taxable year, each partner’s
capital account is equal to the amount that would be distributed to that
partner in liquidation if all partnership assets were sold at their section
704(b) book value, less the partner’s share of minimum gain.

They are distribution driven allocations that have the following
characteristics:
 Liquidation in accordance with the distribution provisions
 “Plug” income so that capital accounts equal what a partner would
receive upon a hypothetical liquidation if the assets of the partnership
were sold for their section 704(b) value
Targeted Allocations
Common Issues/Considerations
 Targeted allocations won’t satisfy the substantial economic effect safe
harbor because they don’t liquidate in accordance with capital account
balances.
 If drafted properly, should be respected under the economic
equivalence test or else are consistent with PIP
 Use of Qualified Income Offset provisions
 Impact of current tax distributions
 Impact on statutory allocations
 Impact of revaluation events

Targeted allocations may create taxable capital shifts
Layered and Targeted Allocations –
The Formulae
Layered allocations compute ending capital under the following formula:
beginning
capital
+
-
contributions
distributions
+
-
income
loss
=
ending
capital
Targeted allocations plug income under the following formula:
target
ending
capital
-
beginning
capital
+
-
income
contributions
distributions
=
or
loss
Layered and Targeted Allocations –
Classic 80/20 Example
o
LP contributes $200 and GP contributes $0 to partnership
o
Partnership buys two securities (1 and 2) for $100 each
o
All distributions are made to LP until it gets its $200 back
o
Then, distributions are made 80% to LP and 20% to GP
o
In Year 2, the partnership sells 1 for $200 (gain of $100)
o
Partnership distributes the $200 of proceeds to LP
Layered Allocation Provision
Section 1. Allocations.
(a) Net Income. Net Income for any period will be allocated:
(i)
First, 100% to the LP until the total Net Income allocated
under this Section 1(a)(i) equals the total Net Loss allocated under Section
1(b)(ii), and
(ii)
(b)
Second, 80% to the LP and 20% to the GP.
Net Loss. Net Loss for any period will be allocated:
(i)
First, 80% to the LP and 20% to the GP until the total Net
Loss allocated under this Section 1(b)(i) equals the total Net Income
allocated under Section 1(a)(ii), and
(ii)
Second, 100% to the LP.
Layered Allocations – Capital
Accounts
LP
Contribution
Gain
Distribution
Total
GP
Book
Tax
200
200
80
80
(200)
(200)
80
80
Contribution
Gain
Distribution
Total
Book
Tax
0
0
20
20
0
0
20
20
Sample Target Allocation Provision Language
“Except as otherwise provided in this Article, Profits and Losses (or items
thereof) for any Fiscal Period shall be allocated among the Members in
such manner that, as of the end of such Fiscal Period, the respective
Capital Accounts of the Members shall be equal to the respective amounts
that would be distributed to them, determined as if the Company were to
(i) liquidate the assets of the Company for an amount equal to their Gross
Asset Value and (ii) distribute the proceeds of liquidation pursuant to
Section 10.3.”

Not all agreements have the “or items thereof” language
 Puts pressure on guaranteed payment determination
 Might make allocation fail economic effect equivalence and fall
into PIP
Targeted Allocations
Targeted allocations are computed under a 6-step process:
Step 1. Determine beginning capital for each partner
Step 2. Allocate contributions and distributions by partner
Step 3. Add Steps 1 and 2 to determine adjusted capital account for each
partner
Step 4. Determine aggregate ending capital
Step 5. Allocate aggregate ending capital to the partners in accordance with
the distribution provisions
Step 6. Subtract Step 3 from Step 5 to determine income for each partner
Targeted Allocation – Capital
Accounts
Step 1. Determine Beg. Capital
Step 2. Determine Contrib. and Dist.
Step 3. Adjusted Capital
LP
GP
Total
200
0
200
(200)
0
(200)
0
0
Step 4. Determine Aggregate End. Capital
0
100
Step 5. Allocate Ending Capital
1st – Return Cap. to LP
2nd – Return remainder 80/20
Total Ending Cap.
0
80
80
0
20
20
0
100
100
Step 6. Taxable Income by Partner
(subtract Step 3 from Step 5)
80
20
100
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