Extract to table

General Rule Under Section 704(b) Section 704(a) of the Code provides the general rule that a partner's distributive share of any item of income, gain, loss, deduction, or credit shall be determined by the partnership agreement

However, Section 704(b) imposes a critical limitation on this general rule: if the partnership agreement's allocation of any such item does not have "substantial economic effect," the item must instead be allocated in accordance with the partner's "interest in the partnership" ("PIP"), as determined by taking into account all facts and circumstances

This framework involves a two-part analysis: first, the allocation must have "economic effect" (i

the allocation must be consistent with the underlying economic arrangement of the partners); and second, the economic effect must be "substantial" (i

the allocation must have a meaningful impact on the dollar amounts received by the partners, independent of tax consequences)

The partnership agreement must require that capital accounts be determined and maintained for each partner in accordance with the rules set forth in Treasury Regulation Section 1