Volume 5 Winter 2011 Number 2 - Charleston Law Review

CHARLESTON LAW REVIEW [Volume 5In analyzing the above facts, there are two potential ways inwhich the cancellation of indebtedness income could be allocated.First, the income could be allocated based on the partnershipincome allocations. If this were done, then the $900x of incomewould be allocated equally between the two partners. As a result,A would be left with a positive capital account of $360x, and Bwould have a positive capital account of $360x. The allocation,however, does not have an economic effect because thepartnership agreement did not provide for an independent deficitrestoration obligation that could be triggered to satisfy the otherpartner’s positive capital account. Additionally, the debtcancellation eliminated the partners’ obligation to restore adeficit capital account. In the absence of an independent deficitrestoration obligation to satisfy positive capital accounts inliquidation, A is left with a positive capital account of $360x, butB is not obligated to restore A’s capital account to $360x. Thus,the allocation based on income allocations has no economic effect.The other way to analyze the problem is to require thecancellation of indebtedness income to be allocated in the sameratio as the decrease in the partners’ share of liabilities under §752. 118 In this case, the income allocated to A would be $90x andto B, $810x. Such a result would accord with economic effectunder § 704. 119 In this situation, the partners’ bases in theirpartnership interests would be increased in accordance with thesame ratios that govern their decrease in their shares ofpartnership liabilities. 120 Accordingly, the deemed distributionsof money to each partner is increased by amounts that exactlyequate to the decrease in bases occasioned by the decrease inshare of partnership liabilities. 121An allocation to a partner of a share of the cancellationindebtedness that differs from the partner’s share of cancelleddebt has substantial economic effect only if: “(1) the deficitrestoration obligations covering any negative capital accountbalances resulting from the [debt cancellation] income allocation252118. I.R.C. § 752(b).119. I.R.C. § 704.120. I.R.C. § 752(b).121. Id.