In bankruptcy k-1 income is not allocated

If a bankruptcy estate has ownership interest in a partnership, estate or subchapter S corporation the k-1 it receives will be for the entire year no matter when the estate was established. In other words the k-1 income for the year is not allocated to time periods before and after the creation of the estate.

This created an interesting tax situation for me when the bankrupt individual received a $500,000 distribution prior to filing bankruptcy and then the bankruptcy estate received a k-1 showing $500,000 in income but had not received the distribution which could have been used for any tax liabilities. In the end, I determined that the $500,000 distribution lowered the bankrupt person’s basis to way below zero which offset most of the tax liability.

Interestingly, the opposite is not true. If the bankruptcy estate sells its interest in the asset then the income is allocated to the estate prior to the sale and to the purchaser after the sale.

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