LLC Charging Order Protection

The charging order protection allows you to make a hostile creditor responsible for taxes although he didn’t yet receive a distribution from your LLC. The hostile creditor thinks he won but quickly recognizes that he must now pay taxes on income not yet received. This process is explained below.

For this charging order protection to be most effective, the LLC must

  • Have at least two (2) members [Important!] Managers can be people or another business.
  • Be taxed as a partnership
  • Management by a manager, not the members. [Important!]

The Assets Are Made Unattractive To The Creditor

The manager of the LLC can refuse to distribute the earnings. (If the operating agreement so allows.) What is the advantage of withholding the distribution from the hostile creditor?

This means that the creditor is now liable for income taxes on those LLC earnings, whether or not they’re distributed. The hostile creditor is now liable for taxes on earnings not yet received or for what is typically referred to as “phantom income.” This places the member in a stronger position to negotiate a favorable settlement. Hostile creditors don’t want to pay taxes on earned income that’s out of reach.