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Bob and Alice form a partnership in the US. Bob is a US citizen. Alice is an Italian citizen residing in Algeria; in the US she pays no capital gains tax, but is taxed higher than Bob on dividends.

At the year's end, the partnership realizes $10k in short-term capital gains and $10k in qualified dividends. Each partner will be distributed $10k on Schedule K-1.

What justifications does the IRS accept for distributing the different tax characters in unequal proportions? Can Bob take all $10k in dividends, and Alice take all $10k in capital gains?

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Can Bob take all $10k in dividends, and Alice take all $10k in capital gains?

They can do whatever they want. The IRS doesn't need justification. As long as the distributions follow the partnership agreement, the IRS doesn't care. There are certain reporting and withholding requirements though for partnerships with foreign partners, so Alice and Bob would probably need to have a good experienced attorney draft their partnership agreement, and a good and experienced tax person (EA/CPA) to handle their reporting and withholding requirements.

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  • But can the partnership agreement specify that the tax characters will be according to what Bob and Alice agree on each year? Or must it specify a specific method without room for discretion? Because Alice's situation may change in future years (i.e. if she becomes a US tax resident).
    – Josh B
    Sep 27 at 16:44
  • @JoshB that's a question to the lawyer who'd be drafting your partnership agreement.
    – littleadv
    Sep 27 at 16:46
  • My lawyer said the opposite of what you answered. But I'm wondering if he might just not know. Is your response backed by something the IRS has published, or just from your general feeling? Thank you.
    – Josh B
    Sep 28 at 15:28
  • @JoshB who asks lawyers about taxes? Is it a tax attorney? If not they know nothing, ask a tax person (EA/CPA).
    – littleadv
    Sep 28 at 16:21

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