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Question: A married couple has operated a limited liability company (LLC) for several years. They are the only owners of the LLC and have always treated it as a partnership, filing Form 1065, U.S. Return of Partnership Income. They are not in a community property state. This past July, one spouse died. Should the 2023 partnership return cover all of 2023? If not, what should the LLC do?

Answer: No. The LLC will need to file Form 1065 from the first day of its tax year to the date of death. The surviving spouse will file a Schedule C, Profit or Loss from Business (Sole Proprietorship), for the remainder of the tax year. Because the taxpayers are not in a community property state, they were correct in filing Form 1065 and treating the LLC as a partnership.

The death of a partner in a two-person partnership causes a technical termination of the partnership for federal tax purposes if it results in only one partner remaining. If this occurs, the partnership’s tax year closes on the partner’s date of death (in this case, July 2023). The surviving partner will file Schedule C on their personal tax filing as a single-member LLC (SMLLC) disregarded entity for the remainder of the calendar year.

This conclusion would not be the case if the deceased partner’s estate, as the successor in interest, continues to share in the partnership’s profits or losses [Reg. §1.708-1(b)(1)(i)]. The partnership’s tax year does not close, and the partner’s distributive share of partnership income from the date of death through the end of the partnership tax year is reported on the tax return of the successor in interest [Reg. §1.706-1(c)(2)(ii)] If this is the case, the partnership would be issuing three Schedules K-1, Partner’s Share of Income, Deductions, Credits, etc. One would be for the complete year on half (assuming the original partners were 50/50 owners) of the partnership results to the surviving spouse. The other half would be divided between one Schedule K-1 for the partner who passed away for the period Jan. 1 to the day before the date of death and a third Schedule K-1 from the date of death through the end of the year for the estate of the decedent issued to the estate’s employer identification number (EIN). When the estate period of administration ends, and assuming the surviving partner is the ultimate successor in interest, leaving only one partner, partnership treatment would end as of that date [§708(b)(1)].

Note: In either scenario, as described, the partnership’s EIN continues to be used either by the now SMLLC or as a multi-member LLC with the estate as the successor partner to the decedent.