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DH's parents built a motel in the 1980s and ran it as an LLC. DH's father died in 1994. DH's mother died in 2009.

DH's sister (DS) continued to run the motel and LLC. DH lived in a different state and did not participate. DS was the executor of her parents' estates. DS failed to file taxes for years starting in about 2013. DS opened probate in 2010 but did not close her mother's estate. Under pressure from DH, the LLC taxes (2014-2019) were finally prepared and the motel sold in 2019. DH owns shares in the LLC, some of which were inherited from his mother.

The LLC had operating losses in 2014 to 2019 which were distributed to deceased Mom's estate on K-1, Part III Box 1. If the LLC had reported ordinary business income in this box, the estate would have issued a K-1 and distributed it to DH and DS.

My question is: Can the estate issue a K-1 which distributes the operating loss to DH and DS? If so, can we deduct it from income (and file amended 1040X for each year)?

I know that it's bizarre to be asking about taxes for years of a deceased person's estate but unfortunately DS didn't file them so we are trying to catch up. There are several indications that DS may be in the early stages of dementia (and/or depression due to the loss of family members and her husband) and wasn't able to manage the business, the estate or the taxes.

Thanks,
Wendy

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Actually, I don’t think there’s anything bizarre about asking the question – taxation of estates and trusts was a significant part of my work for the latter part of my career. That said, your particular situation does have its odd features. And I’m afraid I don’t have any easy, good answers.

I “sort of” recall an earlier discussion about the net operating losses from the LLC which were attributable to the shares that your DH owned and how they affected your personal returns. That was better, to the extent that those losses flowed directly to him and didn’t go through the estate.

As a very general rule, an estate – and a trust in many cases – will pay the tax on its own income, except to the extent that the income was actually distributed, or required to be distributed. It doesn’t work that way with losses, until you get to the final return, in which case the estate ends, and everything for the final year is distributable.

In that final year, when you have net losses, capital losses – current and carried over – are reported as such on the K-1s, with their short-term and long-term designations. And other kinds of net losses and deductions in excess of income are reported as one lump-sum number called “Excess Deductions on Termination.” And that’s a bad thing to see, because it’s a miscellaneous itemized deduction, and those have been “suspended” the last few years. Even in prior years, it was not a good thing, because to deduct it on Schedule A it had to exceed 2% of AGI and you had to add it back for AMT purposes.

So lawyers and accountants try to avoid or minimize that number, if possible, by matching income and expenses, planning the timing of paying the legal, accounting, and other administrative expenses, making the final year long or short, making distributions prior to the final year or not, etc.

But I think you have a big problem if, as you say, the estate has never been closed in court. It would be nice to have a documented date to point to when the estate closed. I suppose, if all assets have been distributed, the case can be made that the estate no longer exists. It may be that the estate could be considered closed in 2019. Was the 2019 return reported as final, based on the K-1 you received?

To answer your question, you need to have a talk with DS, the attorney she worked with on the estate, and whoever prepared the returns for the estate, if it wasn’t the attorney.

Bill
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