The Problem of Abusive Related-Partner Allocations

This Article highlights a flaw in the existing rules regarding partnership tax allocations that has not yet received sufficient attention by existing literature. Namely, the partnership tax allocation rules are implicitly premised on the assumption that partners are unrelated and, thus, transact with each other at arm’s length. As a result, related partners can and do devise tax allocation schemes that exploit the gap in the current partnership tax allocation rules to achieve unwarranted tax savings. This Article proposes to end this abuse by disallowing special allocations among related partners.

Under the proposal, allocations among related partners would be required to be made on a strictly pro rata basis, in accordance with the value of each related partner’s interest in the partnership. While this proposal would rationalize the existing partnership tax allocation rules and prevent abusive related partnership allocations, it would not have any detrimental effect on real economic transactions.