Most post-judgment enforcement remedies employed by creditors result in easily understood and predictable tax consequences to the parties involved. A charging order is different, however, because it peculiarly combines two remedies; namely, an involuntary lien (attachment) against the debtor’s interest in an LLC or partnership, and a non-wage garnishment of the income stream from that interest such that the creditor receives the distributional income and not the debtor. To add to the confusion, in the majority of states the charging order lien may be foreclosed by way of a judicial sale at which the creditor or a third-party may be the winning bidder. All of these actions may result in unforeseen tax consequences to the affected parties as the following article demonstrates.
Once a charging order has been entered, certain tax issues arise. As will be discussed, the treatment of these issues differs between the stage at which the charging order has simply been issued but prior to foreclosure (preforeclosure) and after the creditor’s charging order lien has been foreclosed upon by the creditor (post-foreclosure). Due to the fact that these issues may impact the creditor, the debtor, the entity itself, and the buyer at a judicial sale (who might not be the creditor), consideration of the effect upon these parties at each phase is likewise necessary.
Here, we must be reminded that a charging order is merely the legal vehicle by which a lien is placed by the creditor upon the debtor’s economic right to distributions from the entity. Foreclosure of a charging order correspondingly means that the creditor has liquidated its lien only in the debtor’s economic right to distributions, and whoever ends up owning that interest merely takes that right without more.
Continue reading “Charging Orders and Taxes: Some of the Answers May Surprise You”
