Page 130 - TaxAdviser_2022

hen an owner of a passthrough year end. In general, a partnership’s
Transfers of interests
W entity dies, certain tax implica- year end is determined by the following
tions may arise on both the individual of any kind can affect rules:5
1. The partnership must adopt the
and entity level. This article examines tax year of the partner (or group of
the various federal income tax issues to the partnership’s partners with the same tax year) that
be mindful of in these circumstances. required year end. owns an interest in profits and capital
The discussion first focuses on the of greater than 50%;
effect of a partner’s death on a Sub- 2. If no partner (or group of partners
states if there is a change in a partner’s with the same tax year) owns greater
chapter K partnership, then examines
interest in the partnership during a tax than 50% of profits and capital, then
the consequences of a shareholder’s
year, then each partner’s distributive the partnership must adopt the tax
death on a Subchapter S corporation, share of partnership items must be de- year of all partners owning 5% or
and finally looks at the tax effects of termined in such a way to consider their more of the partnership; and
death for the individual owner and the varying interests. 3. If no partner owns greater than 5%,
owner’s estate and/or trust. The varying interest rules afford or if those that own greater than
partners and the partnership some 5% do not have the same tax year,
flexibility in determining how to al- a calculation must be performed to
Partnership’s tax matters locate partnership items, because the compute the year that generates the
after partner’s death regulations provide for two overall “least aggregate deferral” of taxable
The death of a partner can create many methods to account for variations:2 an income.
complications for a partnership in the interim-closing method or a proration For example, assume that a partner-
tax compliance and planning process. method.3 The interim-closing method ship is owned 40% by a C corporation
Below are some key issues for the part- is the default unless the partnership with a June 30 year end, with the
nership to consider when a partner dies. agreement or other agreement among remainder owned by individuals with a
the partners provides for the use of the Dec. 31 year end. Partner A, who owned
Close of partnership’s tax year proration method. 20%, dies in 2016, and her estate (or her
with respect to deceased partner Note that the proration method trust electing under Sec. 645 to be taxed
Prior to 1997, the death of a partner requires adjustments for “extraordinary” as part of her estate) elects a June 30 year
did not close a tax year with respect to a items (such as sales of assets) that must end. The estate does not distribute the
partner. As a result, any taxable income be specifically allocated based on actual partnership interest until May 15, 2017.
that would otherwise be allocable to the ownership on the date of those events. Assume the interests are distributed to
partner in the year of death was allocable Conversely, a cash-basis taxpayer using individuals with Dec. 31 tax years.
to the partner’s estate (if the estate held the interim-closing method will need to Sec. 706 only requires testing for
the interest at year end) or its beneficia- adjust for cash-basis items collected after a new tax year as of the first day of a
ries (where the interest was not sold or the date of the interim close — attribut- tax year,6 so in 2016 no changes are
deemed sold by the estate). ing an applicable portion of those items required. However, on Jan. 1, 2017, part-
Starting in 1997, changes to Sec. 706 to the prior period.4 ners with a June 30 tax year end hold
meant that a partnership’s tax year would 60% of the partnership. Therefore, a
close with respect to the deceased part- Possible change triggered in the short-period return from Jan. 1, 2017, to
ner.1 Therefore, the partnership must partnership’s year end June 30, 2017, is required. Although on
issue a final Schedule K-1, Partner’s The tax year end of a partnership is gen- July 1, 2017, the general rule would re-
Share of Income, Deductions, Credits, etc., erally a function of the tax year end of quire another change, an exception exists
to the partner with allocations up to the its partners. Transfers of interests of any that allows the partnership to wait up to
partner’s date of death. Sec. 706(d)(1) kind can affect the partnership’s required two years to make this change.⁷

1. Sec. 706(c)(2)(A). 5. Sec. 706(b)(1)(B), Regs. Sec. 1.706-1(b).
2. Regs. Sec. 1.706-4(a)(3). 6. Sec. 706(b)(4)(A)(ii).
3. Regs. Sec. 1.706-4. 7. Regs. Sec. 1.706-1(b)(i)(8)(C).
4. Prop. Regs. Sec. 1.706-2.

www.thetaxadviser.com March 2022 21