-11-
percent of partnership income was allocated to THEI. Rather,
respondent determined that Mr. Manchester should be allocated 99
percent of IHCL's net income for the period after June 20, 1991.
Accordingly, respondent proposed that Mr. Manchester's distributive
share of IHCL's income be increased by $814,296 and that his share
of tax preference items be increased by $23,490. The reallocation
of income reflects the original allocation of income and losses to
Dondi: 1 percent to THEI and 99 percent to Mr. Manchester, as
Dondi's successor. The FPAA stated that "the adjustments in the
distributive shares are determined in accordance with the partners'
interest in the partnership as the partnership has not shown that
the allocation per the return is an allowable allocation under the
provisions of the Internal Revenue Code."
OPINION
In order to determine whether IHCL's allocation of the
partnership items at issue either has substantial economic effect
or is consistent with the partners' interests in the partnership,
we must preliminarily review several basic principles of
partnership taxation.
I. Partnership Taxation
A. General Principles
Section 701 provides that a partnership is not liable for
Federal income taxes; instead, persons carrying on business as
partners are liable in their separate or individual capacities for
the income taxes arising from partnership operations. In
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