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LLC Charging Order Protection

We typically do not recommend that our clients use LLCs to operate a business because California imposes an additional tax on LLCs – the gross receipts tax. In most cases, we recommend an S corporation for an operating business.

However, we like LLCs for owning rental properties because LLCs provide significant asset protection, and there usually isn’t a gross receipts issue with rental properties. Here is what the California Education of the Bar (CEB) says about LLCs:

One of the more important benefits of the LLC is that the assets of the entity are generally not subject to the creditors of its owners. Although a creditor of an LLC member may be able to obtain a charging order or even foreclose on a membership interest, the creditor has only the rights of an assignee, which gives the creditor only the right to receive the distributions that would otherwise have been made.

A charging order does not provide the creditor with the power to exercise any rights or powers of a member. CCP §§699.720, 708.310; Corp C §§15907.02, 15907.03, 17302 (repealed January 1, 2014); Corp C §17705.03 (operative January 1, 2014). Although a membership interest subject to a charging order may be foreclosed, the party acquiring the interest in the foreclosure sale is only entitled to become an assignee in the entity. Corp C §§15907.02, 15907.03, 17302(b) (repealed January 1, 2014); Corp C §§17705.03(b)(3), 17705.02(b) (operative January 1, 2014). Furthermore, if an interest is foreclosed, the creditor may also be treated as the owner of the interest for income tax purposes. The operating agreement will generally provide that if a charging order applies to a member’s interest, the other members, or the or LLC, will have an option to acquire or redeem the affected LLC interest.

 

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