Income taxation of LLC income in year of death.

• Author: Ellentuck, Albert B.
• Position: Limited liability company

For a deceased member, a limited liability company's (LLC's) tax year ends on his or her date of death (DOD); the member's distributive share of LLC income earned through the DOD is reported on his or her final return. Termination of the LLC's tax year also occurs if the LLC terminates on a member's death or because the LLC's business is discontinued or the LLC has only one member remaining. Rev. Rul. 99-6 deals with the consequences of changing from a multi-member LLC to a single-member LLC.

Transfer under a Buy-Sell Agreement

Service LLCs, such as law and accounting firms, often prohibit deceased members' interests from being transferred to anyone but an existing LLC member. To ensure this result, the remaining members (as opposed to the LLC itself) may be required to acquire the interest from the decedent's estate immediately after death. Similar buy-sell agreements may be entered into by members in LLCs engaged in other types of businesses, to provide a market for a deceased member's interest or ensure the remaining members can purchase a deceased member's interest for a price agreed on by the members at some earlier point. In such cases, the LLC's tax year ends as to the deceased member on the DOD; the member is allocated a ratable share of the LLC's income for the portion of the tax year occurring prior to that date. The annual proration or interim closing-of-the-books method can be used to determine the amount of such income required to be reported on the decedent's final tax return.

Note: Because the LLC interest must be included in the decedent's gross estate at fair market value (FMV), a buy-sell agreement that results in the sale of the LLC interest for less than FMV may cause the deceased member's successor-in-interest (e.g., his or her estate) to receive an amount less than the estate tax assessed on the transferred interest.

A purchase under a buy-sell agreement can also cause a technical termination of the LLC and a closing of its tax year as to all members. A technical termination occurs if the deceased member owned at least a 50% interest in the LLC's capital and profits; see Sec. 708(b)(1)(B). A technical termination of the LLC also occurs on the decedent member's DOD if the purchase of the deceased member's interest, along with transfers of other interests during the 12 months immediately before the member's death, add up to 50% or more of total interests in the LLC's capital and profits.

When a technical termination...