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Therefore, if a valid Sec. 754 election IRD is not eligible for a step-up income allocation purposes. All affected
is in place, the partnership can still com- under Sec. 1014(c). Because of this, the shareholders and the corporation must
pute the Sec. 743(b) adjustment without deceased partner’s share of cash-basis consent to this election.
filing an amended return. Instead, the assets included in the estate as IRD can- Is such an election beneficial? It
partnership must report the computed not receive a corresponding basis step- depends on the facts. Administratively,
adjustment on the return in the year it is up under Sec. 743.14 the interim closing of the books may
made aware of the failure and include a Thus, IRD will represent taxable be costly to complete. But making the
statement that the return is being filed income to the beneficiary or estate when election may be worthwhile, particularly
pursuant to Regs. Sec. 1.743-1(k)(5). This recognized by the partnership. If this in situations where extraordinary items
method allows the partnership to pro- income has been subject to the estate occur either pre-death or post-death.
vide the partner with sufficient informa- tax, the beneficiary may take an item- For example, if an S corporation gener-
tion to amend her individual returns to ized deduction for her allocable share of ates a large gain pre-death, perhaps the
account for the prior-year adjustments, the estate tax attributable to any IRD ultimate beneficiaries of those shares
generally in the form of a Schedule K-1 included in the estate.15 Therefore, if would prefer that the decedent pay her
footnote, without filing amended returns the partnership has any items of IRD, full share of tax on that item rather
(or AARs) for the partnership itself. it should report the information to the than burdening the beneficiaries with
estate or to the new partners on their a portion of the gain (and the related
Limitation or reduction of Schedules K-1 so they are aware of the tax). If the decedent’s estate is subject
Sec. 743 step-up potential deduction. to estate tax, the payment of tax on that
Sec. 743 step-up may be limited or gain on the decedent’s final income tax
reduced for cash-basis items and other S corporation’s tax matters return will reduce the estate tax obli-
income in respect of a decedent (IRD). after shareholder’s death gation. The best course is not always
In addition, the partnership may need As with a partner’s death, the death of clear, so modeling the implications
to report IRD information to the estate a shareholder can create many com- is important.
and the new partner. IRD can include plications for an S corporation in the
the decedent’s share of unearned income tax compliance and planning process. Inadvertent termination of
from a partnership interest. Therefore, Below are some key issues for an S the S election
this income is includible in the value of corporation to consider when a share- Without question, the failure of S
the decedent’s estate. IRD specifically holder dies. corporations and successor shareholders
includes any outstanding Sec. 736(a) to fully consider the implications to the
payments (such as retirement payments) Reporting of income and loss in corporation’s Subchapter S status after
owed to the deceased partner.12 the year of death a shareholder’s death is the most com-
In addition, the estate of a deceased In an S corporation, a shareholder’s mon cause of inadvertent terminations.
partner of a cash-basis partnership may pro rata share of income and loss is Why? In many cases, the successor
be required to include unrealized cash- normally determined by allocating shareholder, whether that be the estate,
basis income allocable to the deceased equal portions to each day of the year a testamentary trust, or a beneficiary,
partner.13 However, some practitioners and then allocating those items to does not recognize that it might need
argue that this position is not supported the shareholders based on the shares to take certain steps to remain a quali-
by Sec. 691 and that cases that have in- outstanding on each day.16 However, in fying shareholder.1⁷ By the time some-
cluded such items as IRD were in error. a year where a shareholder’s interest in one does recognize, for example, that a
This position relies on an argument that the S corporation terminates, such as qualified Subchapter S trust or electing
such rules only apply to partnerships upon death, the corporation can elect small business trust election has been
where capital is not a material income- under Sec. 1377(a)(2) and Regs. Sec. overlooked, it may be too late.
producing factor for the partnership 1.1377-1(b) to do an interim closing of Just as troubling is the fact that, in
— which would treat cash-basis items as the books, treating the S corporation’s many cases, the S corporation may have
Sec. 736(a) payments. tax year as two separate tax years for no insight into what its shareholders

12. Sec. 753. 15. Sec. 691(c).
13. George Edward Quick Trust, 54 T.C. 1336 (1970); Woodhall, T.C. Memo. 16. Sec. 1377(a)(1).
1969-279. 17. Secs. 1361(b)(1)(B) and 1361(c)(2)(A); Regs. Sec. 1.1361-1(h)(1).
14. Regs. Sec. 1.742-1; Rev. Rul. 66-325.

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