In essence, a Charging Order allows a judgment creditor to receive such distributions from certain forms of companies (e.g., partnerships, limited-liability companies and now, Nevada corporations) as a judgment debtor would have received. It is important to note that a judgment creditor does not have access to the company’s assets and has no management or voting rights.

There are important points relating to Charging Orders:

(1) the charging order is a lien against the judgment debtor’s interest and does not allow the judgment creditor to foreclose against the debtor’s interest;

(2) the creditor cannot exercise any management or voting rights because the creditor has “only the rights of an assignee of the member’s interest;

(3) the creditor has no other remedies available but the Charging Order.

Charging Orders and Single Member LLCs or Single Shareholder Corporations:

In In re: Ashley Albright, a Bankruptcy Court in Colorado held that a the charging order protection does not apply to single-member LLCs since, the Court held, charging orders were intended to protect non-debtor “partners,” and in single-member LLCs there is no one to protect. As the language of the Colorado LLC statutes does not exempt single-member LLCs from the protection of the charging order and so, many practitioner’s are uncertain as to the true applicability of Albright.

In community property states, a Court following Albright would probably treat a married couple as a single member and thus would likely not afford the owners of the charging order protection.

This is the final entry in CenterPoint Corporate Service’s discussion on business entity forms.  For more information, please visit CenterPoint Corporate Service’s Frequently Asked Questions.  Don’t hesitate to contact us for a more detailed discussion.

Generally:

Limited Liability Companies (“LLC”) are a relatively new form of business entity and is somewhat of a hybrid between a partnership and a "S" corporation. LLC's provide a partnership‘s flexibility of operations with the limitation of personal liability on its owners as in a corporation.

The LLC's tax benefits come from the partnership tax rules. Accordingly, it avoids certain ownership restrictions that may exist within the "S" corporation tax rules. An owner of an LLC is called a “Member”. LLC’s can be managed by the Members or preferably, by “Managers” appointed by the Members.

Attributes of a Limited Liability Company (“LLC”):

LLC'S V. "C" CORPORATIONS

As mentioned in a prior section, a shareholder of a "C" corporation is subject to a double level of tax: first at the corporate level and then, when dividends are paid, at the shareholder level. A LLC is a "flow-through" entity and owners are taxed as if the LLC were a partnership.

"C" corporation shareholders cannot deduct corporate losses. Again, being a "flow-through" entity means that any business losses pass through to the owner of a LLC who is able to deduct the business loss.

Lastly, a "C" corporation may be subject to accumulated earnings tax or personal holding company taxes. Since a LLC is not governed by Subchapter "C", there is no accumulated earnings tax or personal holding company tax and accordingly, there is no restriction on the amount of investment income an LLC can receive relative to its active business income.

LLC'S V. "S" CORPORATIONS

The tax rules governing "S" corporations are restrictive regarding the number and characteristics of its shareholders. For instance, a "S" corporation can not have over 75 shareholders, and the shareholder can not be another corporation, a partnership, a nonresident alien, a non-qualified trust, a pension plan or a charitable organization. LLC's have no such ownership restrictions.

An "S" corporation cannot have more than one class of stock. A LLC can have multiple ownership classes which may allow for a special allocation of tax attributes.

If a corporation is converted to an LLC, the IRS treats it as a termination of the corporation. Therefore, there may be significant tax implications to the corporation and its shareholders.

LLC'S V. PARTNERSHIPS

General Partnerships. Partnerships and LLC's have the same ability to make special allocations of tax attributes. However, LLC’s liabilities are always nonrecourse and must be allocated according to the partners' interests in the partnership (i.e., reasonably consistent with allocations of some othersignificant partnership items).

Limited Partnerships. As mentioned in the section dealing with Limited Partnerships, Limited Partners who participate in management of limited partnership risk loss of limited liability status. There is no problem with a LLC owner materially participating in the management of an LLC. In fact, it is recommended that an owner materially participate in order for any LLC losses to be considered nonpassive to the owner.

If a partnership is converted to an LLC, the IRS does not treat it as a termination of the partnership and, accordingly, there are no tax implications of such a conversion.

Passive Loss Rules:

Since members of LLC's may participate in management without loss of their limited liability status, losses of an LLC to participating members is nonpassive.

Check back in a few days for a discussion of Charging Order Protections.  This is part 7 of 8 in the CenterPoint Small Business Blog’s series on Business Forms.

In this series of posts, we will be discussing the advantages and disadvantages of various business entities.  These entries are meant to be tips and to guide your thinking on business forms.  But, they should not take the place of a discussion with your lawyer, tax advisor, or accountant.

Selecting the form in which to operate a business is one of the most significant decisions an owner will have to make. The choice of business form can have broad implications, not only for the manner in which the enterprise will be conducted, but for the personal affairs of the owner. A strong corporate shield can also shield your personal assets from your business liabilities. Forming a business entity is vital to protecting yourself and gaining the legal and tax benefits from operating a business.

Among other issues, the choice of business form can directly affect:

• The decision about what property the client will contribute to the business.
• Whether the owner or the business will be responsible for the business' obligations.
• Whether, and in what form, the business will continue after the client has ceased to participate in it.
• How interests in the business may be transferred and other participants brought in (or allowed out)
• How the owner's personal income tax liability will be calculated.
• What the client's optimum estate plan should be.

The choice of business form will also have a significant impact upon the relative complexity or simplicity of the client's legal and financial affairs and upon the degree of financial risk to which the owner(s) will be exposed.

Making a sound decision on the choice of business form often requires the owner to look beyond his or her current business situation to examine such matters as the business' long and short term prospects, as well as the general tax and financial affairs of the owner and, in many cases, those of the owner's family and business associates.

There are a number of basic forms of business presently in Nevada but there are six worth discussing – Sole Proprietorship, General Partnership, Limited Partnership, "C" Corporation, "S" Corporation and Limited Liability Companies. Each form has various advantages and disadvantages.

Stay tuned to the CenterPoint Small Business Blog for a discussion of the benefits and limits of each form of business.  A discussion of the first form, a Sole Proprietorship, is forthcoming.