| ||The Disappearing Limited Deficit Restoration Obligation |
Michael A. Oberst*
*Professor of Law, Fredric G. Levin College of Law, University of Florida; University of Florida, B.S.B.A. 1963, J.D. 1968. The author gratefully acknowledges Professors George K. Yin and Gregg D. Polsky for their thoughtful comments on the draft of this article and Todd Hood and Nick Livers for their research assistance. The author also acknowledges and is grateful for the the support of the University of Florida College of Law's summer research grant program.
The purpose of the partnership "economic effect" regulation rules is to achieve consistency between the ways that partners share items of income and deduction for tax and economic purposes. Thus, the allocation of a $100 tax deduction to a particular partner will not be respected unless that partner suffers a corresponding $100 economic burden. Similarly, an allocation for tax purposes of $100 of income to a partner will not be respected unless that partner receives a corresponding $100 economic benefit.
To determine the extent to which a partner has been economically burdened or benefited, the regulations focus on the effect that an allocation has on a partner's "capital account." The paramount concern of these regulations is to prevent an allocation from creating a deficit balance that the partner would not be obligated to repay, known as an "impermissible deficit." The regulations provide a remedy, the "qualified income offset" (QIO), for various unexpected capital account reductions that cause impermissible deficits. In order to eliminate the impermissible deficit, the QIO requires that the partnership, as quickly as possible, allocate a sufficient amount of gross income to the partner involved.
However, the QIO does not apply to impermissible deficits arising in situations where a partner is effectively relieved from a potential obligation to pay a partnership liability. The purpose of this Article is to explore these situations. Part II describes the economic effect rules, with particular emphasis on those situations in which a partner's contingent responsibility to pay a partnership liability is considered a limited obligation to repay a capital account deficit. Part III discusses Revenue Ruling 1992-97, which reveals this problem in the context of a debt cancellation situation. Part IV explores other situations, such as a partner's guarantee of a partnership liability, to illustrate that the problem is not restricted to debt cancellations. Part V describes how the minimum gain chargeback rules avoid impermissible deficits with respect to losses that are financed by nonrecourse liabilities. In this context, the application of the minimum gain chargeback rules to a special type of nonrecourse liability incurred by limited liability companies and limited liability partnerships is also discussed. Part VI concludes with a proposal to expand the application of the QIO to those situations in which a partner is left with an impermissible deficit as a result of the elimination of that partner's contingent obligation to pay a partnership liability.