Partnership income normally reflects ownership. If, say, you own 60 percent of the business, you're entitled to 60 percent of the income and are liable for 60 percent of the losses. If you want to divide things differently -- a "special allocation" -- you need to show the Internal Revenue Service that you're not doing it to hide taxable income. One way to prove you're legit is the qualified income offset. You have to write provisions for the qualified income offset into your partnership agreement.
How Offsets Work
The qualified income offset governs how the partnership allocates profit and loss to capital accounts. Each partner has a capital account, which holds the partner's original investment and her share of business profits, less any profits she withdraws for herself. With a QIO, your firm can't make a special allocation if it puts a partner's capital account into the red or makes a negative balance even worse. Instead, you have to allocate enough money to that partner to put her account back into the black as soon as possible. This shows the IRS you're not allocating losses just to reduce one partner's taxable income.