Many people think the LLC charging order is a flexible strategy that provides strong asset protection. Here are some of tactics that don’t work with charging order protections.
Colin Ley is an asset protection attorney and the creator of the PREP Trust® and Better LLC™. He is also the co-founder of LayRoots (along with with partner in life & business – Shreya Ley)
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Many people rely on the charging order protection for their LLC as the single tool or strategy for their asset protection plan.
Yes, that’s true.
And this charging order protection is not giving them the protection that they think they’re getting–
For a number of reasons.
Tell me, Colin.
So let’s explore some of them.
One way they’re not getting protection is the idea that you can circumvent the charging order by, instead of taking money out of your LLC, instead of taking a distribution, to instead call it a loan. Your LLC is going to loan you some money, and then, you know, you put this agreement in place that you’re going to pay it back somehow. So it’s not a distribution, it’s not profits coming out, it’s just a loan. Seems like a great idea.
Sure, it sounds very clever.
Right, and clever things might work for a while, but attorneys that are coming after people, and judges–
They’re gonna figure out this clever trick.
They start to figure out these clever tricks, so when you have a knowledgeable or a competent attorney who is trying to enforce judgment, they find ways to avoid this. So, when they ask for the charging order, they’re not just asking for distributions, they’re saying that “no money can come out of this LLC. “If anything comes out, it’s mine.” And we’ve found that judges are agreeing with those attorneys.
So another reason that these charging orders are not giving the protection that people are hoping for, another way to try to circumvent these charging orders is to give yourself a salary. So again, it’s avoiding the idea of a distribution coming out. Instead, it is a salary coming out, to pay you for your management services.
Something like that.
Which can be allowed by peoples’ operating agreements.
And it makes sense, but again what we’ve seen, it’s a clever trick. And judges have ruled that if you weren’t paying yourself a salary before, you can’t suddenly start paying yourself a salary now. You can’t become a salaried employee if you weren’t before.
All of a sudden.
Right, cause you’re obviously just trying to–
Get money out.
And you’re trying to frustrate the creditor, which is not allowed.
That’s a no-no. The other thing to consider is, most states allow wage garnishment as well. So if you start–
That’s what I was about to say.
If you start in Washington here, I think it’s 20%, so if you did start taking a salary, the creditor would just start taking–
So, it’s a sadness.
It’s a sadness, it is.
A sadness if you were relying on that tactic.
If that’s your only tool.
Yeah. Okay, so the next way in which a charging order is not providing the protection people might think–
Thank you for that clarification.
There’s an idea that you can just tax your creditor away. Basically, you’re like, “Okay, fine. “I’m not going to take any distributions, “but now since you’ve got this charging order, “you’re gonna get the tax liability. “So no money is gonna come out, “but you’re still gonna have to pay the taxes “on money that we earned.”
And again, initially, I think people agreed with that. They’re like, yes–
That makes sense, because you’re owning a part of this now.
Yes, but again, smart attorneys figured out ways to circumvent this or you know, to close these types of loopholes, and eventually the people that be, the IRS, they’ve ruled that no, if you’re just holding the charging order, if you just have a lien on this LLC interest, you don’t have to pay the taxes. In this case, the creditor does not end up having to pay your taxes for you. So it’s not going to scare them away, it’s not gonna to make them change their mind about a charging order, or make ’em go away, or whatever you’re hoping for. Finally Shreya, people might not be getting the protection they think from their LLC because they’re hoping they can wait out their creditor. They’re like, “Fine, I’m not gonna make any distributions. “If you’re waiting to take my distributions, “I’m just not gonna make them.”
“I’m okay, I can survive”.
Yeah, but can you? Because, that charging order can last for 20 years. 20 years.
That’s a long time.
You’re not gonna take any distributions for 20 years?
What’s the point of having these investments if you’re not able to take advantage of the money you’re making from them?
And if you’re trying to wait somebody out, you’re like, “Fine, I’ll wait it out”. When people get a judgment against you, they will often ask for interest on the judgment. And it’s not like prime rate plus one, it’s like 12% interest. So if you’re telling your creditor, “I’ll just wait you out.” They might say, “Okay, the interest is tolling now”. But yeah, so waiting someone out, your wait period could be 20 years. If you’re relying on a domestic LLC charging order protection. So, there’s many reasons that this charging order protection was a good idea. These laws were made to address the problems of our legal system, where judgements can be handed out like candy. But the good intentions that they had, or however they worked at the beginning, the other side has figured out how to close down those benefits.
And some of the loopholes.
So even with those good ideas that are on the books, on the legal books, they’re not always the protection that you think they are.
Well thank you, Colin.
That was very informative.