Closing the Partnership’s Books. Under IRC § 706(c)(2)(A), the taxable year of a partnership closes when a partner dies. The question remains, however, whether events such as specific bequests, residuary bequests or other distributions by an estate or living trust would require the partnership to close its books. Guidance needs to be provided as to when the partnership’s taxable year is closed in these circumstances.
When a partner dies and terminates his interest in a partnership, 2 different methods are used to allocate items of partnership income. The first is an interim “closing of the books; which effectively separates the partnership year into 2 segments. The first segment is the period prior to the partner’s death, the second is the period after the partner’s death. Income realized in each segment is then allocated to the persons who were partners during each of those segments.
The second method for allocating partnership income for the year a partner dies is the proration method. Under the proration method, all items of partnership income for the year a partner dies are allocated amongst the partners based on the number of days that year the partner was a partner. Under this method, a deceased (former) partner is allocated a portion of partnership income for the year regardless of when the partnership realizes the income.
Because of the differences in the way each of these methods allocate income between the partners, depending on the particular circumstances, one method may be “better” than the other. Thus, it is imperative that the executor work with the partnership’s accountant in selecting the best method of allocating partnership income between the estate and the other partners.
Regardless of which method is chosen, cash basis partnerships must use the accrual method to allocate interest, taxes, payments for services or the use of property other than guaranteed payments under IRC § 83, and any other items specified in the regulations. The partnership is required to assign a portion of these items to each day in the period to which it is attributable. This “daily portion” is then further assigned to the partners in proportion to their respective partnership interests at the close of each day. This mitigates against a partner’s ability to time payment of large cash basis expenses (such as real estate taxes and payments for services) for tax purposes. (IRC § 706(b)(2).)
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