Planning for distribution of partnership interest at death.

• Author: Torrance, Debbie R.

The transfer of a partnership interest by a deceased partner can result in unexpected income tax consequences. Therefore, it is important to determine who will be taxed on the decedent's share of partnership income or loss in the year of death.

The death of a partner generally does not result in the termination of a partnership; see Sec. 708(b). Under Sec. 706(b), if the partnership does not terminate, the tax year of the partnership does not close as a result of the partner's death. in this case, the decedent's last income tax return generally does not include income or loss from the partnership; as under Sec. 706(a), the last income tax return of the decedent partner includes only his share of the partnership income for any partnership year ending within or with the decedent's last year (i.e., the year ending with his death). Thus, if a calendar-year partner in a calendar-year partnership dies prior to December 3 1, the partner's share of the partnership income f or the calendar year is included in the income tax return of the estate or other successor partner. partnership is not permitted to allocate the portion of the income earned during the decedent partner's lifetime to the decedent.

As a result of Secs. 706 and 708, the decedent's final return may not have sufficient income to fully use exemptions and deductions to which the decedent was entitled. Alternatively, if the partnership generates substantial losses in the year of the partner's death, the estate may not have other income to be offset by the losses. Taxpayers have three basic options to avoid these potential adverse consequences.

First, the deceased partner may name his spouse to succeed to his partnership interest after death in accordance with the terms of the partnership agreement. If the spouse is designated as the successor in the partnership interest, the share of the partnership income or loss for the partnership year ending within or with the spouse's tax year is included in the spouse's tax return. Since the surviving spouse can file a joint return with the decedent through the date of death, naming the spouse as successor in interest avoids including the partnership income or loss in the estate. Alternatively, the decedent can...