by Richard Keyt, Arizona LLC, corporate and business lawyer
This article is part of a series of nine related articles I wrote about the seven types of entities used in Arizona to operate a business and to hold business assets and investment real estate. The articles are: (1) the “Best” Arizona Entity, (2) limited liability companies, (3) sole proprietorships, (4) general partnerships, (5) limited partnerships, (6) C corporations, (7) S corporations, (8) business trusts, , and (9) the entity comparison table. The type of entity can have significant income tax and asset protection consequences. The articles discuss the entities in terms of ease and cost of formation, number of owners & restrictions on ownership, privacy, control and management, owners protection from liabilities of the entity, and federal income taxation issues.
The LLC is the “Best” Arizona Entity
Almost always the best type of entity to form in Arizona is the limited liability company. In reality, few people form any type of entity other than an LLC or a corporation. In general, Arizona LLCs offer the following advantages over the other types of entities:
- Cheaper to form
- Cheaper to operate (no requirement for annual meetings and minutes)
- Fewer legal formalities
- Better asset protection (because of fewer legal requirements)
- More choices on how the entity can be taxed for federal income tax purposes (4 for LLC vs. 2 for corporations)
- No annual report due the State of Arizona (required of AZ corporations)
- No annual fee due the State of Arizona ($45/year for AZ corporations)
- Last, but certainly not least: a charging order is the exclusive remedy of a creditor who gets a judgment against the owner)
What is a Charging Order & Why is it Important?
Arizona LLC law provides that members of an Arizona LLC have charging order protection. Shareholders of an Arizona corporation do not. Arizona Revised Statutes Section 29-655 states:
“A. On application to a court of competent jurisdiction by any judgment creditor of a member, the court may charge the member’s interest in the limited liability company with payment of the unsatisfied amount of the judgment plus interest. To the extent so charged, the judgment creditor has only the rights of an assignee of the member’s interest. . . .
C. This section provides the exclusive remedy by which a judgment creditor of a member may satisfy a judgment out of the judgment debtor’s interest in the limited liability company.”
If a creditor who holds a judgment against a member of an Arizona LLC applies to an Arizona Superior Court for a charging order and the court issues the charging order, the creditor will then serve the charging order on the LLC or LLCs in which the member/debtor has a membership interest. The legal significance on the LLC that is served with a charging order is that the LLC becomes subject to a court order that says that if the LLC intends to distribute any money or property to the member/debtor, the LLC must deliver the money or property to the creditor rather than to the member/debtor. If the member/debtor has control of the LLC, the member/debtor can cause the LLC to refrain from making distributions to the member/debtor, which means the creditor will get nothing from the LLC.
If the characteristics of Arizona LLCs and corporations were exactly the same except for the charging order protection given to members of an Arizona LLC, then this fact alone would be the reason to form an Arizona LLC instead of an Arizona corporation. The following example illustrates the legal significance of having charging order protection vs. not having it.
LLC vs. Corporation Asset Protection Examples
Example 1 (corporation): Homer Simpson own all of the stock of an Arizona corporation that has a value of $300,000. Homer loses a lawsuit to Ned Flanders who gets a judgment for $25,000. Homer has cash flow problems and cannot come up with the $25,000 he owes Ned. Ned uses the Arizona debt collection process to sell all of Homer’s stock of the corporation at a public auction. Only one person shows up for the auction. The bidder offers $10,000 for the stock, which is then sold to the highest bidder. Result: Homer lost his $300,000 company and he still owes Ned $15,000.
Example 2 (LLC): Same facts as Example 1 except Homer owns an Arizona LLC instead of an Arizona corporation. Because Arizona LLC law provides that Ned’s sole remedy is to serve a charing order on the LLC, Ned cannot force a sale of the LLC. Result: Homer retains all of his LLC and its $300,000 value.
The night and day different result in Examples 1 & 2 illustrates why the Arizona LLC is the best type of entity to form in Arizona.
Arizona Corporation Commission Entity Formation Statistics
During the last ACC fiscal year that ended June 30, 2012, people formed 50,328 Arizona LLCs and 6,704 Arizona for profit corporations. The Arizona LLC is 7.5 times more popular than Arizona corporations. Most people forming Arizona corporations do not know that the corporation is an obsolete entity that should be used only in a few select circumstances. See “ACC Entity Formation Statistics.”
Here is my list of the only times I recommend forming an Arizona corporation over an Arizona limited liability company:
- The company will sell securities to investors who prefer to purchase stock rather than membership interests in an LLC.
- A medical doctor wants to form a professional entity and all or almost all of the other doctors in his or her medical group formed professional corporations.
- A person has always owned and operated corporations and insists on using a corporation.