Special Allocation: Federal deduction for NJ BAIT

[tbrain9393]

Hello, 

I have a question regarding support for a potential Federal special allocation for NJ BAIT. 

Facts: Partnership ABC has three partners, Partner A who is an individual that owns 65%, Partner B who is an individual that owns 15%, and Partner C which is a corporation that owns 20%. Partner A and Partner B are heavily involved in operations and get paid guaranteed payments of 150,000 each per year. Partner C is not involved in operations and does not receive a guaranteed payment. In the current tax year, there is a loss of 100,000 on the federal side. On the New Jersey side, the guaranteed payments get added back, so there is a 200,000 net income. If the partnership elects NJ BAIT, can the partnership make a special allocation to allocate the Federal deduction for NJ BAIT to Partners A and B and none to Partner C? How does 704(b) support this?

[sjrcpa]

I don't see why you couldn't/wouldn't specially allocate the federal deduction. (Do you mean as an addback on the NJ K-1?)

It will have substantial economic effect since the NJ tax itself will be allocated according to the NJ income taxed to each partner.

[tbrain9393]

Thank you for your reply. It is definitely an additional back for New Jersey. 

It does seem like it would have substantial economic effect because of how the tax is allocated on the New Jersey side. However, is this enough to claim substantial economic effect on the Federal side? 

In this specific scenario, the guaranteed payments to the two partners are deductions on the Federal side, but not deductions on the NJ side. So on the NJ side, the guaranteed payments are allocated as income to the two specific partners and the same partners receive the NJ credit. On the Federal side, there is no corresponding income specifically allocated to the partners receiving the guaranteed payments at the entity level. As a result, how is there substantial economic effect if the BAIT deduction is specially allocated but there is no corresponding income to the same partners?

[sjrcpa]

Good question.

But I don't think substantial economic effect necessarily means only federal (EDIT) or state income tax effect.

[tbrain9393]

I agree. I just don't see clear 704(b) support for the allocation. Would you mind providing your logic using the example I gave in my original post?