Keystone LLP has three partners (U, V, and W). The partnership agreement provides a special allocation under IRC Section 704(b) that allocates 100% of charitable contributions to U, with all other items shared equally. For the year, Keystone has $150,000 of ordinary business income and a $12,000 charitable contribution (separately stated). Assuming the special allocation has substantial economic effect, based on the partnership agreement, how should income be allocated?
- Allocate $50,000 of ordinary income to each partner, and allocate the $12,000 charitable contribution entirely to U. (correct answer)
- Allocate $46,000 of ordinary income to U and $52,000 to each of V and W to offset the charitable contribution allocation.
- Allocate $150,000 of ordinary income and the $12,000 charitable contribution equally among U, V, and W.
- Allocate the $12,000 charitable contribution to U and allocate all $150,000 of ordinary income to U because U receives all separately stated items.
Explanation: This question tests IRC Section 704(b) special allocation of charitable contributions as separately stated items. The agreement allocates 100% of charitable contributions to U with substantial economic effect, while other items are shared equally among three partners. U receives the entire $12,000 charitable contribution deduction, and the $150,000 ordinary business income is allocated equally at $50,000 to each of U, V, and W, making Answer A correct. Answer B incorrectly attempts to offset the charitable contribution allocation by adjusting ordinary income allocations, which violates the agreement. Answer C ignores the special allocation entirely, and Answer D wrongly allocates all ordinary income to U. The key principle is that special allocations under IRC Section 704(b) apply only to the specifically designated items, and other items follow the general allocation provisions without adjustment for the special allocations.