Target Allocation Agreements and the Service Partner

It is important to properly draft target allocation provisions, by examining a variety of such provisions. Certain partnership allocations concern income, gain, loss, and deductions, called target allocations. Target allocations specify how cash is distributed from operations and in liquidation of a partnership. A model then allocates income or loss items to partners capital accounts so that these accounts conform to a cash distribution scheme.

Author Terence Cuff writes: Key characteristics of "target allocations" are: (1) the partnership does not explicitly liquidate in accordance with capital accounts but rather liquidates in accordance with stated percentages, explicit tiers, etc., that do not depend explicitly on capital account balances, and (2) allocations of income and loss items are made in such a manner that capital accounts are adjusted to be consistent with the plan for liquidating distributions of cash.

...

Treasury and the Internal Revenue Service drafted Treasury Regulations concerning partnership allocations (Treas. Reg. § 1.704-1 ("Allocation Regulations") and regulations concerning allocations of deductions attributable to nonrecourse debt (Treas. Reg. § 1.704-2) ("Nonrecourse Deduction Regulations") prior to prevalence of target allocation provisions. This time was prior to prevalence of limited liability companies. Neither the Allocation Regulations nor the Nonrecourse Deduction Regulations expressly address target allocation provisions.

The failure of the Allocation Regulations and Nonrecourse Deduction Regulations expressly to consider the tax effects of limited liability companies leaves considerable doubt concerning the status of target allocation provisions under these two regulations. Nonrecourse deductions create special issues (discussed below) when a partnership uses a target allocation provision. A special allocation of nonrecourse deductions outside of the target allocation provision may not qualify under the Nonrecourse Deduction Regulations. An allocation of nonrecourse deductions under the target allocation provision may not qualify under the Nonrecourse Deduction Regulations.

...

We will leave it to the future to explore the nuances of whether the target allocation provision will yield results that accord with partners' interests in the partnership. This can involve a difficult analysis. Partners may not have the benefit of a presumption of unlimited solvency.

Subscribers can access the complete commentary on lexis.com. Additional fees may be incurred. (Approx. 13 pages)