What happens when an LLC member dies — and why the heirs inherit an income rather than a say

How an LLC handles a death is not decided after the death. It was decided when the operating agreement was signed, or — far more often — when nobody got round to signing one and the state's default rules moved in. Those defaults are coherent, deliberate and almost the opposite of what families assume.

The estate inherits the cheque, not the seat

LLC law splits a member's position in two. The transferable interest is the economic half: distributions and the allocated share of profit and loss. Everything else — voting, management, the right to demand records, the standing to sue — is governance, and governance is not property that can be handed to a stranger. The Uniform Law Commission calls this fidelity to the "pick your partner" principle, and it is why the default answer on death is so blunt.

The model act does it in three moves. Section 602(7)(A) dissociates an individual member on death. Section 603(a) provides that the right to participate in management terminates and that the interest is from that moment "owned by the person solely as a transferee". Section 502(a)(3) then says what a transferee may not do: participate in the management or conduct of the company's affairs, or have access to records or other information about them. Section 502(b) states the whole of what remains — distributions, "in accordance with the transfer".

So the family inherits the distributions and no way to cause one. If the survivors reinvest the profit, pay themselves salaries and declare nothing, there is nothing to receive — and the estate cannot vote against it, see the ledger it would need to challenge it, or make anyone buy the interest out.

Two states look generous and are not

Delaware and New York are the deviations everyone cites. Section 18-705 of the Delaware act provides that where a member dies, "the member's personal representative may exercise all of the member's rights for the purpose of settling the member's estate or administering the member's property, including any power under a limited liability company agreement of an assignee to become a member". New York's LLC Law § 608 is worded almost identically.

Skimmed, that sounds like the estate steps into the seat. It does not. The rights are exercisable for the purpose of settling the estate — an administrative purpose, not a licence to run the business — and the power to become a member is expressly "any power under a limited liability company agreement", the agreement's power rather than the statute's. Where the agreement makes death a withdrawal, § 18-705 supplies the machinery to collect the money and nothing more.

The model-act states are franker about the same result. Section 504 gives a deceased member's legal representative the transferee's right to an account from the date of dissolution and, for the purposes of settling the estate, the information rights the member held. Both are information rights. Neither is a vote.

That leaves the executor with a fiduciary duty to realise value and no lever to realise it with. They can collect distributions, gather enough information to value the interest and file the return, sell it subject to the transfer restrictions, and negotiate weakly with owners who want it back. They cannot vote it, appoint a manager or force a payment. The estate-tax regulation at 26 CFR § 20.2031-3 asks what a willing buyer would pay for the decedent's interest as it actually stands — no control, no ready market — which is what discounts for lack of control and marketability measure. Not a planning trick; a description of what is held.

The buy-sell clause is the only part of this decided in advance

Of the three routes an agreement can take, admission suits a spouse the co-owners are content to work with, an option suits owners who want the choice, and a compulsory buyout is the one most people mean. The choice matters less than whether the money exists behind it. Triggers, valuation method and payment terms work as they do on any exit — buying out a business partner covers them. Death changes two things about that machinery.

That is why these clauses are funded with life insurance, and why where the policy sits now matters more than it used to. In Connelly v. United States (6 June 2024) the Supreme Court held unanimously that a company's obligation to redeem a dead owner's interest at fair market value is not a liability offsetting the insurance proceeds held to fund it — the proceeds are a company asset, they raise the company's value, and the estate is taxed on the higher figure. The Court pointed to the cross-purchase alternative, where the owners insure each other and the proceeds never reach the company, while noting its own drawbacks. Company-owned funding is not wrong. It is a decision that now has a size to it.

The second change is that the agreed price does not automatically become the price for estate tax. Under 26 CFR § 25.2703-1 a right or restriction is disregarded for transfer-tax valuation unless it independently satisfies three tests: bona fide business arrangement, not a device to pass value to family cheaply, and terms comparable to arm's-length arrangements. The regulation adds a trap most agreements walk into — where the terms require the price to be updated periodically, "the failure to update is presumed to substantially modify the right or restriction", which re-dates it to the day of the failure and re-opens all three.

When the member who died was the only member

The single-member LLC is the hard case, because dissociation leaves the company with no members at all — and an LLC with no members is on a clock. The model act, and Florida's § 605.0701(1)(c) word for word, dissolves a company after "the passage of 90 consecutive days during which the company has no members", unless transferees owning a majority of the distribution rights consent to admit someone and that person becomes a member inside the window. Delaware's § 18-801(a)(4) arrives at the same place from the other direction, naming the personal representative of the last remaining member as the person who must agree to continue.

The trap is the calendar. Somebody with authority has to give that consent, and until a court appoints a personal representative nobody has it. Probate appointment is not quick, and it is slower where the will is contested. In the meantime nobody can sign for the company, banks freeze accounts they cannot verify a signatory for, and the annual report goes unfiled — which under the model act's § 708 is itself a ground on which the filing office may begin administratively dissolving the company, after notice and a 60-day grace period.

The fixes take a paragraph and have to be written years earlier: a successor admitted automatically on death, with power to act pending probate, and for a Delaware company a line obliging the personal representative to continue it. A single-member operating agreement that omits this carries the most common serious defect in the document. Holding the interest through a revocable trust sidesteps most of the problem, because the trust does not die — but that is a transfer like any other, and one made in breach of a restriction the transferee knows about is simply ineffective. See funding a revocable living trust for the consent to get first.

The tax question nobody warns the heirs about

A small one first. For an LLC taxed as a partnership, the taxable year closes with respect to a partner who dies (26 CFR § 1.706-1(c)(2)(i)). The distributive share up to the date of death lands on the decedent's final personal return; everything after belongs to the estate. Two K-1s, two returns, and a bill that arrives whether or not cash was distributed.

The larger one is basis. The heir's basis in the inherited interest is stepped up to date-of-death value. The company's basis in its own assets is not — and the regulation is unusually direct about why: the basis of partnership property is adjusted on the death of a partner "only if the election provided by section 754 ... is in effect with respect to the partnership" (26 CFR § 1.743-1(a)).

What matters is whose election it is. It belongs to the company, not the heirs: the survivors are asked to take on a permanent accounting obligation for a benefit accruing to someone else's family. Left to a conversation during an estate administration, that goes badly. Written into the operating agreement as an obligation to elect on request, it costs nothing to agree while everyone is alive.

One last check. If the LLC elected to be taxed as an S corporation, the shareholder-eligibility rules bite: a trust holding the interest after a death is generally a permitted shareholder for only two years, with QSST and ESBT elections available to extend it. Missing that terminates the election for the whole company, which is why an S-electing LLC needs an accountant in the first month rather than the first year.

None of this law is obscure or new. It is written into the model act in plain words and adopted state after state, and it still lands as a shock, because the paragraph that would have changed the outcome was skipped by people who were busy starting a company and had no intention of dying. The clause costs a page. Not having it leaves a family owning the income from a business they can do nothing with.