If your partnership is facing this challenge, here are three accounting issues you will need to address in the immediate aftermath.

1. Normal Distributive Shares

The normal activities of the partnership usually result in a portion of earnings being distributed to each partner and reported annually as income. The deceased partner's estate will be due his or her portion of this normal distribution until the date of their death. Generally, this would be paid to their heir or as stipulated in their estate planning documents.

The business will need to be careful to separate income earned prior to the person's death from that earned after their passing. The type of income is also important to record for tax purposes. Your accountant will be the best resource to help with this division of income.

2. Income in Respect of a Decedent

What happens to money that wasn't yet earned when the partner passed away? This is known as income in respect of a decedent (IRD) and it is paid to and reported to the decedent's heirs. Examples of IRD include guaranteed payments paid after the date of death, their portion of business interest earned after death, or income earned by the partnership between the partner's death and the dissolution of their interest.

Why is it so important to distinguish between a partner's final distributions and that earned after their death? First, the income is reported in different ways for tax purposes. In the case of the former, the estate would generally report earnings for income taxes whereas in the latter case, earnings would be reported by heirs. Second, self-employment taxes are due only for what was earned until the person's death.

3. Buying Out the Partner

Once your business has handled final income distributions and reporting, you will have to deal with the issue of succession. A good partnership agreement usually has already addressed whether the partner's heirs or spouse can simply take over their position in the business or not. If the partner's particular skills or training was unique, for example, it may not be feasible for someone else to take over.

If an heir doesn’t take over, the partnership will need to distribute the partner's portion to liquidate their interest. Normally, there are two methods of doing this. One is for the other partners to personally buy out (and assume) the deceased person's interest. The other is for the business to do so as an entity. The current partners and the partnership agreement will determine the method.

The biggest problem most partnerships face when buying out a deceased person's interest is how to value the company. Some businesses can use the value of assets owned by the business as well as the partner's stake (or basis, in accounting terms) in the enterprise. Service businesses, though, may have a much harder time determining value due to the ephemeral nature of future earnings.

A partnership that needs to property account for these financial matters after a partner's passing should work closely with an experienced accountant. The accountant can help determine the treatment of income, advise of tax year changes, value the partner's interest, and calculate an appropriate buyout amount. 

At Bliss & Skeen Certified Public Accountants, we are ready to assist your business during this difficult time for you and your partnership. Call today to make an appointment and learn more about our partnership accounting services.