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The alternative test begins by incorporating the first two
parts of the basic test. (As with the basic test, the partnership
agreement must provide for properly maintained capital accounts.
It must also provide that the proceeds of liquidation are to be
distributed in accordance with the partners’ positive capital
account balances.) However, instead of a negative capital account
makeup requirement, the alternative test mandates a hypothetical
reduction of the partners’ capital accounts. Specifically, the
alternative test requires that capital accounts be reduced for any
distributions that, as of the end of the year, are reasonably
expected to be made, to the extent that such distributions exceed
reasonably expected increases to the partners’ capital accounts.
See sec. 1.704-1(b)(2)(ii)(d), Income Tax Regs. By requiring a
prospective reduction of capital accounts, the alternative test
serves to preclude a limited partner from timing the receipt of
deductible partnership expenses in a way that permits a partner to
accumulate a negative capital account that the partner need not
repay.
The alternative test also requires that the partnership
agreement provide for a “qualified income offset” (QIO). A QIO
provision automatically allocates income, including gross income
and gain, to a limited partner who has an unexpected negative
capital account, either as a result of partnership operations or as
a result of making the adjustment for reasonably expected
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