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Taxation of Partnerships and Partners, par. 1.05[1], at 1-14 (4th
ed. 2007). Only the first part of the rule (section 1.701-2(a)
through (d), Income Tax Regs.) is pertinent to this case.
Section 1.701-2(a), Income Tax Regs., is entitled “Intent of
subchapter K”. It states: “Subchapter K is intended to permit
taxpayers to conduct joint business * * * activities through a
flexible economic arrangement without incurring an entity-level
tax.” It further states that there are three requirements
“[i]mplicit in the intent of subchapter K”: (1) “The partnership
must be bona fide”, and the transaction(s) in question “must be
entered into for a substantial business purpose”, (2) the
transaction(s) must not violate substance over form principles,
and (3) the tax consequences under subchapter K “must accurately
reflect the partners’ economic agreement and clearly reflect the
partner’s income” unless any departure from that standard is
“clearly contemplated” by the applicable provision of subchapter
K or the regulations thereunder.
Section 1.701-2(b), Income Tax Regs., entitled “Application
of subchapter K rules”, provides, in pertinent part:
[I]f a partnership is formed or availed of in
connection with a transaction a principal purpose of
which is to reduce substantially the present value of
the partners’ aggregate federal tax liability in a
manner that is inconsistent with the intent of
subchapter K, the Commissioner can recast the
transaction for federal tax purposes, as appropriate to
achieve tax results that are consistent with the intent
of subchapter K * * * . Thus, even though the
transaction may fall within the literal words of a
particular statutory * * * provision, the Commissioner
can determine * * * that to achieve tax results that
are consistent with the intent of subchapter K * * *
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