When a partner in an LLC dies, the company does not automatically end. Under most state LLC statutes, the deceased owner is “dissociated” from the business the moment they die, the surviving members keep full management control, and the deceased member’s economic interest, meaning the right to distributions and a share of profits, passes to their estate or heirs. What happens next depends almost entirely on the operating agreement. Without one, state default rules take over, and those defaults often produce results the family did not expect.
Dissociation Separates the Money From the Management
Most states have adopted some version of the Revised Uniform Limited Liability Company Act. The default rule is simple: death dissociates the member, but it does not dissolve the LLC. The surviving members continue operating the business, and the deceased member’s connection severs automatically.
An LLC membership interest has two parts. The economic rights cover distributions, profits, and losses. The management rights cover voting, decision-making, and access to company information. When a member dies, only the economic rights transfer to the estate. The management rights do not pass to the heirs at all. The estate becomes what the statutes call a “transferee” or “assignee,” entitled to money but not to a seat at the table.
That distinction is the heart of what trips families up. An heir who inherits a 40% economic interest in a profitable LLC has no right to vote, no right to inspect the books, and no right to force a distribution. They cannot compel dissolution. If the operating agreement is silent, they are stuck with whatever the surviving members decide.
Where Heirs Get Squeezed
Because transferees have no management rights, surviving members who control distributions can effectively starve the heir’s interest. They can reinvest profits back into the business, pay themselves generous salaries, or structure transactions that benefit the people still inside the company. The heir sees little or nothing. Many states impose fiduciary duties on members, but whether those duties extend to transferees is unsettled in most jurisdictions, so an heir who suspects something is wrong may have a hard time doing anything about it without litigation.
This is the strongest practical argument for addressing death in the operating agreement before anyone dies. Once a member is gone, the people with power to fix the problem are the ones benefiting from it.
Two-Member LLCs Face a Harder Problem
When an LLC has only two members and one dies, the company drops to a single member. In some states a “memberless” LLC must dissolve within a short statutory window unless a replacement member is admitted. Even where continuation is allowed, the surviving member now holds 100% of the management rights, and the estate holds a transferee interest with no voice at all.
The tax picture also shifts automatically. A two-member LLC is taxed as a partnership by default. A single-member LLC is treated as a disregarded entity for federal tax purposes. The reclassification happens on its own and brings new filing requirements. If the surviving member and the estate want to restore partnership treatment, the estate or an heir would need to be admitted as a full member, which usually requires the surviving member’s consent.
For a two-partner LLC, skipping the operating agreement puts the entire business at risk of dissolution or a long fight over whether the estate can force a buyout.
How the Operating Agreement Rewrites the Default
The operating agreement can override nearly every default rule above. A well-drafted agreement handles death directly and typically covers four things.
It can grant heirs the right to become full members, preserving both economic and management interests. Or it can prohibit heirs from joining and require a mandatory buyout instead. It can specify how the deceased member’s interest is valued, whether by book value, a formula tied to revenue or earnings, or an independent appraisal. It can set a timeline for the buyout so the estate is not waiting years for payment. And it can address management continuity, naming a successor if the deceased ran day-to-day operations or spelling out how one gets chosen.
Valuation is where most disputes start. When the agreement is silent, surviving members push for a low number and the estate pushes for a high one, and the fight usually ends with court-appointed appraisers and significant legal bills. Specifying the method in advance removes most of that risk.
LLCs without an operating agreement run entirely on state default law, and those defaults were drafted to cover the broadest possible range of situations, not any particular business.
Buy-Sell Agreements and Insurance Funding
A buy-sell agreement is a separate contract, sometimes folded into the operating agreement, that pre-commits the parties to a transaction when a triggering event like death occurs. It names the buyer, sets the price or the method for determining it, and fixes a timeline.
Most buy-sell agreements are funded with life insurance, because without a cash source, surviving members may not have the liquidity to actually complete the purchase. Two structures dominate.
In a cross-purchase arrangement, each member owns a life insurance policy on the other members. When one dies, the survivors collect the death benefit and buy the deceased member’s interest directly. Each buyer’s tax basis in the acquired interest equals the price paid, which can reduce taxable gain if the LLC is later sold. The structure gets unwieldy as membership grows: three members need six policies, five members need twenty.
In an entity-purchase or redemption arrangement, the LLC itself owns and pays for policies on each member. When a member dies, the LLC collects the proceeds and redeems the interest. Administration is simpler, especially with many members, but the surviving members do not get a direct basis increase from the purchase. Choosing the wrong structure is the kind of mistake that stays invisible until someone tries to sell years later and gets a tax bill they did not expect.
Probate, Trusts, and Transfer-on-Death
A deceased member’s LLC interest is part of their estate and generally passes through probate, the court-supervised process for paying debts and distributing assets. Probate can take months or years depending on the estate’s complexity and local court backlogs. During that time the interest sits in limbo from the estate’s perspective, even though the surviving members keep running the business.
If the operating agreement is silent on what happens at death, probate and the agreement’s transfer restrictions can collide, creating delays and confusion about whether the heir can actually step into the member’s shoes.
Some states allow transfer-on-death designations for LLC interests, passing the interest directly to a named beneficiary outside probate. Not every state recognizes TOD designations for LLC interests, and even where they are allowed, the operating agreement has to permit them. A TOD designation that conflicts with a buy-sell provision or transfer restriction may be unenforceable.
Holding the interest in a revocable living trust is another common approach. The trust owns the interest during the member’s lifetime and continues to hold it after death, bypassing probate. The successor trustee named in the trust can step in immediately and manage the interest under the trust’s instructions.
Tax Consequences
Death triggers several overlapping tax events for the estate, the heirs, and the surviving members. Some work in the taxpayer’s favor; others create traps that are easy to miss.
Estate Tax
The deceased member’s LLC interest is valued at fair market value for estate tax purposes. For 2026, the federal estate tax basic exclusion amount is $15,000,000 per individual, so estates below that threshold owe no federal estate tax.1Internal Revenue Service. What’s New – Estate and Gift Tax Estates above face a top federal rate of 40% on the excess. Some states impose their own estate or inheritance taxes at much lower thresholds, so an estate well under the federal limit may still owe state tax.
Valuing a closely held LLC interest is rarely clean. The IRS expects fair market value, which typically involves discounts for lack of marketability and lack of control. Getting it wrong in either direction creates problems: overvaluation inflates the tax bill, undervaluation invites an audit.
The Final Return and the Partnership’s Tax Year
The partnership’s tax year closes with respect to the deceased member on the date of death, even though the partnership’s overall year continues for everyone else.2Office of the Law Revision Counsel. 26 U.S. Code 706 – Taxable Years of Partner and Partnership The deceased member’s share of LLC income, losses, deductions, and credits from January 1 through the date of death goes on their final individual return. Income earned after the date of death is allocated to whoever holds the interest at that point.
The Step-Up and the Section 754 Election
Property acquired from a decedent generally receives a new tax basis equal to its fair market value at the date of death.3Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent The heir’s “outside basis” in the LLC interest resets to current value, potentially wiping out years of built-in gain.
The catch is that the step-up applies to the heir’s basis in the interest itself, not automatically to the LLC’s internal basis in its assets. To align the two, the LLC must file a Section 754 election with the IRS.4Office of the Law Revision Counsel. 26 U.S. Code 754 – Manner of Electing Optional Adjustment to Basis of Partnership Property Once the election is in effect, the LLC adjusts its internal asset basis with respect to the transferee under Section 743(b) to match the heir’s stepped-up outside basis.5Office of the Law Revision Counsel. 26 U.S. Code 743 – Special Rules Where Section 754 Election or Substantial Built-in Loss The adjustment applies only to the transferee, not the other members.6Internal Revenue Service. FAQs for Internal Revenue Code (IRC) Sec. 754 Election and Revocation
Without the election, the heir ends up with a mismatch: a high outside basis from the step-up and a share of the LLC’s low inside basis in assets that may have appreciated for years. That mismatch can produce phantom income from depreciation recapture or asset sales, even though the heir inherited the interest at full value. Surviving members sometimes resist making the election because of the administrative cost, but for the heir the stakes of skipping it can be significant. The election is filed with the LLC’s tax return for the year the death occurred, so the window closes quickly.
Income in Respect of a Decedent
Not everything the heir receives benefits from the step-up. Items classified as “income in respect of a decedent” (IRD) are taxed to the estate or heir when received, keeping the same character, ordinary or capital, that the deceased member would have recognized.7Office of the Law Revision Counsel. 26 U.S. Code 691 – Recipients of Income in Respect of Decedents The step-up rule explicitly does not apply to IRD items.3Office of the Law Revision Counsel. 26 U.S. Code 1014 – Basis of Property Acquired From a Decedent
In the LLC context, the most common IRD items are the deceased member’s share of unrealized receivables and any guaranteed payments owed but not yet paid at death. For service businesses with significant receivables, the IRD hit can be substantial, and heirs are often surprised because they assumed the step-up covered everything.
What the Surviving Members Should Do Right Away
The operating agreement is the first document to pull. It dictates the timeline and procedures for everything that follows, and any buy-sell provisions are triggered the moment the member dies.
- Notify the estate’s executor or personal representative and open communication about the deceased member’s interest, pending distributions, and the ownership process.
- Secure the LLC’s financial records and prepare a valuation of the interest as of the date of death. The estate needs it for estate tax purposes, and the surviving members need it if a buyout is triggered.
- Contact the LLC’s accountant about a Section 754 election if one is not already in place. The election is filed with the return for the year of death, so delay can mean missing it.
- Review any life insurance policies tied to buy-sell agreements and start claims immediately, since those proceeds fund the buyout and a cash shortfall will strain the LLC.
- Check whether the state’s articles of organization need amending if the deceased was listed as a member or manager.
The worst outcome is paralysis. When surviving members avoid dealing with the interest, the estate’s transferee rights stay unresolved, tax deadlines slip, and the relationship with the heirs deteriorates. Moving quickly, even through uncomfortable conversations, protects the business and the deceased member’s family at the same time.