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With regard to the matter before us, the parties agree that
the IHCL Restated Agreement complies with the first two
requirements. (The agreement provides that the partners’ capital
accounts will be properly maintained and that liquidation proceeds
will be distributed to the partners in proportion to their positive
capital account balances.) However, neither the IHCL Restated
Agreement, nor any of its amendments, require partners having
deficit capital account balances to restore the deficits to zero
upon liquidation of the partnership. Accordingly, the special
allocation of 100 percent of IHCL’s net income for 1991 to THEI did
not meet all the requirements necessary to satisfy the basic test
of substantial economic effect.
(2) Alternative Test of Economic Effect
Limited partnership agreements (such as the IHCL Original
Agreement) usually provide specific limits upon the amount the
limited partners are required to contribute to the partnership.
These limits on liability, however, are inconsistent with the
requirement in the basic test that upon liquidation each partner
must agree to repay the deficit balance in that partner’s capital
account. Consequently, an alternative test for economic effect has
been developed to provide that special allocations of partnership
items may have economic effect even in the absence of an unlimited
deficit restoration requirement.
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