Partner's Taxable Income Allocation in Year of Exit

Technical topics regarding tax preparation.
#1
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Partners A, B, C and D are LLC members in an entity treated as a partnership (where capital is not a material income producing factor). A will sell his entire interest to B for cash in, say, October 2021. All of the partners have agreed orally (subject to further guidance) that A will be allocated no taxable income for 2021.

What facts and authorities, if any, would support an allocation of no taxable income to A for 2021?

Am I on the right track:

1. Does the varying interests rule in 1.706-4 override 761(c) where a partner's interest completely terminates during the year?

2. If 1.706-4 does not override 761(c), could the partners amend the LLC operating agreement to provide for a zero allocation in the year of exit and adjust capital accounts accordingly?

3. If on the other hand 1.706-4 does override 761(c) in this case, is the only argument for allocating no income to A, the argument that such an allocation results form applying a "reasonable method to account for the varying interests of the partners in the partnership during the taxable year" under the 1.706-4(b)(2) safe harbor?

4. If 1.706-4(b)(2) is a viable route, might it be reasonable to argue (if supported by the facts) that A provided no services during 2021 and therefore should be allocated no income in the current year?

Many thanks!
 

#2
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Having thought about this some more, in the context of a service partner who exists in the middle of a tax year during which he did no work for the partnership, it might be appropriate to say his distributive share of CY income is nil. Technically, this would result from applying the varying interests rule and making the argument that the particular "reasonable method" referred to in 1.706-4(b)(2) is some sort of "service hours" method. That is, we count the exiting partner's hours (0) through his date of exit and allocate taxable income accordingly.

Curious if all this sounds reasonable?
 

#3
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. That is, we count the exiting partner's hours (0) through his date of exit and allocate taxable income accordingly.

Services hours sounds like a reasonable method, but like you said it'll depend on whether the facts fit the conclusion.
 

#4
Nilodop  
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I believe your post #2 is on the right track. Section 704 is the general rule for allocating partnership income and you'd clearly be OK under its principles. Reg. 1.704-1(b)(iv) does provide
Similarly, an allocation that is respected under section 704(b) and this paragraph nevertheless may be reallocated under other provisions, such as section 482, section 704(e)(2), section 706(d) (and related assignment of income principles), and paragraph (b)(2)(ii) of § 1.751-1. If a partnership has a section 754 election in effect, a partner's distributive share of partnership income, gain, loss, or deduction may be affected as provided in § 1.743-1 (see paragraph (b)(2)(iv)(m)(2) of this section).
, but I don't see where your proposed allocation is a problem. You're not avoiding taxes, you're doing what makes economic sense among the partners.
 

#5
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Thanks all!
 


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