You are the senior tax associate in a small public accounting firm. The largest client of the firm is a man named Will “Big Daddy” Varner. Big Daddy owns numerous businesses mainly through his status as the sole shareholder of a Subchapter S Corporation or the sole member a Limited Liability Company (LLC) for each particular business (e.g., a cotton farm, a tobacco farm, a timber operation, a coal strip mine, a gas station, a grocery store, a men’s and women’s clothing store, a farming and industrial machinery supply warehouse and many others). Through these business entities, he controls virtually the entire economy of a rural county in West Tennessee.

Big Daddy’s longtime college friend is the most senior partner in your accounting firm and the firm’s accounts with him represent more than 90% of its income. So you know that keeping Big Daddy happy is not only essential to the firm but also essential to your future employment and to your prospects for becoming a partner in the accounting firm.

Recently, Big Daddy’s son Jody, a “slip and fall” sole practitioner lawyer in Memphis, has been approached by Flem Snopes, a “slick talking “ real estate developer about having Big Daddy invest in a multi-member LLC that will own a major real estate (residential, industrial and commercial) development in an adjacent county. This development would be financed mostly through a nonrecourse bank loan. But it is in desperate need of initial startup capital and there will be some recourse debt mainly through accounts payable to suppliers and contractors.

The real estate development is expected to produce an inordinate amount of tax losses early in its history. Flem is prepared to allocate virtually all of these losses to Big Daddy if he will become his major equity contributor. Jody has frequently heard Big Daddy brag about and long for the days of President Reagan when tax losses were plentiful and when sometimes you could report these huge losses without having to pay for them. Big Daddy frequently emphasizes the latter because you are aware that Big Daddy is very suspicious of any enterprise where he may be responsible for anyone else’s debt.

Your senior partner has asked you to provide a tax research memorandumto the client file and a letterto Big Daddy and Jody explaining the rules for specially allocating tax losses/deductions keeping in mind Big Daddy’s aversion to paying for anyone else’s debt. In addition, Jody has mentioned seeing differing provisions dealing with special allocations to LLC members: one providing that a member must restore any deficit balance in his capital account and one not so providing but including in it the odd term “Qualified Income Offset.” Jody has also mentioned seeing the term “Minimum Gain Chargeback.” Your task is to explain the special allocation rules to Jody and Big Daddy and how these terms might apply to Big Daddy should he invest in Flem Snopes’s development. Keep in mind that Big Daddy is an old relatively unsophisticated southern gentleman and that Jody is merely a “left turn” lawyer and that your future and your firm’s prosperity may depend upon you explaining to these two unsophisticated individuals these complex matters.