Substantiality of Economic Effect of paying 100% of all LLC expenses out of pocket by one managing member

Question

Two partners with 50% interest in an LLC.

One partner is paying 100% of all LLC expenses for the first year so expects to take 100% income or loss. This allocation is done because the other partner does not have any income, assets, or capital to contribute other than experience. In fact, the financially non-contributing partner will be filing a $0 income tax return for the year.

There is no capital investment other than exactly whatever bills are racked up during the startup phase. Beginning and ending capital account would be 0 as all expenses incurred are paid off immediately and directly. Current year net would be a loss. Capital contributed during the year would be amount contributing partner paid in expenses from personal funds less any income the LLC made.

Under Sec. 704(b) regulations, would this pass IRS requirements for a "Substantial Economic Effect" so the financially contributing partner can claim special allocation of 100% on Form 1065 (Schedule K-1)?

There are no assets in the LLC. These are almost exclusively operating and advertising expenses incurred, if that matters.

Answer 1

If you agreed upfront to take part in post-startup phase economics, maybe that would qualify. If not, the arrangement doesn't seem to have economic effect with respect to you:

The general rule in regards to economic effect, is that an allocation has economic effect only if during the life of the partnership, the partnership agreement provides for: one, the determination and maintenance of a partner’s capital account in accordance with a maintenance requirement; two, liquidating distributions are made in accordance with partner’s capital account balance (positive capital account balance) even when taking into account adjustments for the current year; and, three, that a partner with a negative capital account balance is absolutely required (mandated) to restore their capital account by contributing cash or property to the partnership.

https://jmtaxlaw.com/what-is-economic-effect-in-substantial-economic-effect/