https://www.thetaxadviser.com/issues/2022/mar/tax-issues-shareholder-partner-dies.html
if the LLC is a partnership due to changes in IR C 706, this can be a complicated issue. this is a simplified overview of the above. for more info see the article link and if unsure consulting a pro is advisable.
Starting in 1997, changes to Sec. 706 meant that a partnership's tax year would close with respect to the deceased partner. Therefore, the partnership must issue a final Schedule K-1, Partner's Share of Income, Deductions, Credits, etc., to the partner with allocations up to the partner's date of death. Sec. 706(d)(1) states if there is a change in a partner's interest in the partnership during a tax year, then each partner's distributive share of partnership items must be determined in such a way to consider their varying interests.
After a partner's death, the partnership may be required to allocate all post-death income to the beneficiary of an estate that received the interest, even if the estate held the interest for a period of time before the distribution. This is related to the fact that the changes to Sec. 706 implemented in 1997 did not affect the treatment of a transfer via inheritance or testamentary transfer. Therefore, a transfer to a beneficiary from an estate (or a trust electing to be taxed as part of an estate under Sec. 645) that is not reported as a sale by the estate does not close the partnership tax year with regard to the estate. The beneficiary should receive the Schedule K-1 and be allocated income for the full portion of the tax year that the interest was owned by the estate.8
If non-pro-rata distributions of partnership interests are made to residuary beneficiaries, consideration should be given to choosing a termination date of Jan. 1. Otherwise, the tax consequences will not be divided evenly based on the percentage interests of the beneficiaries. Therefore, in many cases, if an estate (or a trust that has made a Sec. 645 election) that held a partnership has been opened and closed within the same tax year, it is likely that the estate would not receive a Schedule K-1. Instead, the Schedule K-1 should go to the decedent up to the date of death and to the beneficiary for the remainder of the tax year. However, if the estate holds the interest as of the partnership's year end, it would receive a Schedule K-1.
A partnership must have a valid Sec. 754 election ( this allows for adjustment of tax basis for the estate or heirs where Fair market value is more than the carrying tax basis of the decendent's share of the net assets) of basis in place or make such an election in the year of death to allow the estate or beneficiary to benefit from a Sec. 743 step-up. However, relief is available for a missed election. The partnership has up to 12 months from the extended due date of the tax return to make such an election, regardless of whether an extension was actually filed.9
This late election can be made in the form of an amended return (or administrative adjustment request (AAR) for partnerships subject to centralized partnership audit procedures under the Bipartisan Budget Act of 201510 for tax years ending after Dec. 31, 2017) filed within 12 months of the return's due date with extensions. The phrase "Filed Pursuant to Reg. Section 301.9100-2" needs to be included in the header of the amended return or in the explanation section of an AAR.
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for an S-Corporation
S corporation's tax matters after shareholder's death
As with a partner's death, the death of a shareholder can create many complications for an S corporation in the tax compliance and planning process. Below are some key issues for an S corporation to consider when a shareholder dies.
Reporting of income and loss in the year of death
In an S corporation, a shareholder's pro rata share of income and loss is normally determined by allocating equal portions to each day of the year and then allocating those items to the shareholders based on the shares outstanding on each day.16 However, in a year where a shareholder's interest in the S corporation terminates, such as upon death, the corporation can elect under Sec. 1377(a)(2) and Regs. Sec. 1.1377-1(b) to do an interim closing of the books, treating the S corporation's tax year as two separate tax years for income allocation purposes. All affected shareholders and the corporation must consent to this election.
the downside to an S-Corp is there is no section 743/754 election available.
