Estate of Melvin W. Ballantyne, Deceased, Jean S. Ballantyne, Independent Executrix, and Jean S. Ballantyne - Page 20




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          partners, then the allocation will be recognized provided it has            
          substantial economic effect.16  Sec. 1.704-1(b)(1)(i), Income Tax           
          Regs.  Substantial economic effect requires that (1) the                    
          allocation have economic effect and (2) such effect is                      
          substantial.  Sec. 1.704-1(b)(1)(i) and (2), Income Tax Regs.               
               An allocation has economic effect if, and only if,                     
          throughout the full term of the partnership, the partnership                
          agreement provides: (1) The partners’ capital accounts be kept in           
          accordance with the regulations; (2) liquidating distributions be           
          made in accordance with positive capital account balances; and              
          (3) a partner must be required to restore a deficit capital                 
          account balance following the liquidation of the partnership or             
          of his interest in the partnership.  Vecchio v. Commissioner,               
          supra at 189; sec. 1.704-1(b)(2)(ii)(b), Income Tax Regs.  An               
          allocation does not have economic effect if it fails to satisfy             
          any of the three parts of the test.  Vecchio v. Commissioner,               
          supra at 189.  In the instant case, capital accounts were never             
          maintained; thus, the proffered allocations fail the economic               
          effect test.                                                                
               The regulations under section 704 also provide an alternate            
          test for economic effect, contingent on satisfaction of                     
          requirements (1) and (2) above.  Sec. 1.704-1(b)(2)(ii)(d),                 


               16The “substantial economic effect” test is applicable to              
          all partnership allocations, not just “special allocations”.                
          Hogan v. Commissioner, T.C. Memo. 1990-295.                                 





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