That's the bottom line question. Surprisingly few creditors apply for charging orders – and for one good reason: The charging order creditor can become liable for federal taxes due on the partnership profits earned by the debtor-partner, even if the creditor never receives profit distributions from the partnership. Consider the creditor with a charging order against a limited partner who owns a 50 percent partnership interest. If the partnership earns $100,000 a year, the 50 percent debtor-partner pays income taxes on $50,000 as 'pass-through' income. Instead, the charging order creditor assumes the partner's tax liability, even if the creditor received no distribution. Therefore, a creditor in a 35 percent tax bracket would pay a $17,500 tax each year the charging order is in effect, assuming the partnership generates the same profits. So if there are undistributed profits, the creditor has only a tax liability. And several states prevent a charging order creditor from releasing their charging order without the consent of the debtor-partner. A debtor-partner with taxable income from the partnership may understandably withhold this consent. You can see how the charging order can easily become a liability rather than a way to recover on a judgment. The shift of tax liability from the debtor-partner to his charging order creditor is true only in certain circumstances that are too technical to detail here; but a good Asset Protection attorney can usually structure the limited partnership so that the possibility of the creditor incurring a large tax debt becomes a real deterrent to a creditor pursuing the charging order.
