{"id":3226,"date":"2010-09-23T08:35:55","date_gmt":"2010-09-23T15:35:55","guid":{"rendered":"http:\/\/www.keytlaw.com\/azllclaw\/?page_id=3226"},"modified":"2025-02-09T09:23:25","modified_gmt":"2025-02-09T16:23:25","slug":"10-critical-llc-facts","status":"publish","type":"page","link":"https:\/\/www.keytlaw.com\/azllclaw\/forming-llcs\/10-critical-llc-facts\/","title":{"rendered":"10 Critical Facts Every LLC Owner Must Know"},"content":{"rendered":"

by Richard Keyt<\/a>, an Arizona LLC attorney who has formed 10,000+\u00a0Arizona limited liability companies and has 406\u00a0five star Google, Facebook & BIrdeye reviews<\/a><\/p>\n

Richard has practiced business law and been forming companies in Arizona since 1980. He has a masters degree in federal income tax law (LL.M.) from New York University School of Law. Rick taught a class on LLCs at Arizona Summit Law School and speaks frequently on Arizona LLCs.<\/p>\n

This article is applies only to Arizona limited liability companies. The LLC is the most popular entity being formed in Arizona.\u00a0 People form about 12 Arizona LLCs for every one Arizona corporation formed.\u00a0 The LLC is the Arizona entity of choice for many reasons, including, but not limited to:<\/p>\n

1.\u00a0 It is cheaper to form and cheaper to operate than an Arizona corporation with respect to complying with Arizona law,<\/p>\n

2. A corporation can be taxed only two ways under federal income tax law, but an LLC can be taxed four ways, including the same two ways a corporation can be taxed,<\/p>\n

3. An Arizona corporation must comply with six corporate formalities required by Arizona law, but an Arizona LLC is not subject to any of these formalities, and<\/p>\n

4. It is harder for creditors to pierce the company veil and hold the members of an LLC liable for the debts of an LLC than it is a corporation.<\/p>\n

For a detailed explanation of why the LLC is the entity of choice in Arizona, read my article called “LLC vs Corporation<\/a>.”<\/p>\n

I urge you to read my article called “How LLCs Protect Your Life Savings<\/a>.”\u00a0 It explains clearly why you must put your Arizona investment real estate and Arizona business in an Arizona limited liability company to prevent the loss of your life savings and the loss of the economic well-being of yourself and your family<\/strong>.<\/p>\n

The following is my list of the ten critical facts every LLC owner must know about Arizona limited liability companies:<\/p>\n

10. DO NOT FORM MEMBER MANAGED LLCS<\/strong><\/span><\/p>\n

To form an LLC, you file Articles of Organization with the Arizona Corporation Commission. The Articles must state that the LLC will be (i) member managed, or (ii) manager managed. Unless there is a good reason to form a member managed LLC, you should form a manager managed LLC because the members of manager managed LLCs can select the person or entity to have management powers. EVERY member of a member managed LLC has management powers, which means EVERY member can sign contracts on behalf of the LLC and obligate the LLC on obligations. You may not care if all initial members have management power, but if somebody transfers all or a portion of their membership interests voluntarily, as a result of death or divorce or if a creditor acquires a member\u2019s interest, do you really want the new member to have the power to sign contracts and bind the LLC to legal obligations?\u00a0 I never form member managed Arizona LLCs.<\/p>\n

9. MEETINGS OF MEMBERS AND MANAGERS ARE NOT REQUIRED<\/strong><\/span><\/p>\n

Arizona law does not require that members or managers of an Arizona LLC hold annual or special meetings or file an annual report or pay an annual fee to the Arizona Corporation Commission. Arizona law does require Arizona corporations to have annual meetings of shareholders. The meetings should be documented with minutes or resolutions signed by all of the shareholders. Arizona corporations must also file an annual report with the Arizona Corporation Commission and pay an annual fee to the Arizona Corporation Commission.\u00a0 Despite the fact Arizona law does not require members or managers of an LLC to hold annual meetings, I recommend that the members and managers of all Arizona LLCs hold annual meetings and that the meetings because it is a prudent business practice.<\/p>\n

8. S CORP TAX ELECTION MUST BE MADE WITHIN 75 DAYS OF THE LLC’s FORMATION<\/strong><\/span><\/p>\n

One of the ways an LLC can be taxed for federal income tax purposes is as an \u201cS corporation.\u201d If the LLC elects to be taxed as an S corporation, the LLC always remains an LLC, but it is treated by the IRS as an association taxed under Subchapter S of the Internal Revenue Code. Not every LLC can be taxed as an S corporation because the Internal Revenue Code has requirements that must be met to be eligible to elect S corporation status. The main reason an LLC might want to elect S corporation tax status is because the LLC would not pay federal income tax. Members of an LLC that elects S corporation taxation must report all income or loss on their personal tax returns. S corporation taxation avoids the potential for double taxation that applies to entities that are taxed as C corporations.<\/p>\n

If an eligible LLC wants to be taxed as an S corporation from the date it is created, all members must sign an IRS form 2553 and the form must be filed with the IRS within 75 days of the date the LLC was formed. If the LLC does not file the form 2553 timely, it will not be taxed as an S corporation for its first year or later years. However, an LLC may file the form 2553 within the first 75 days of the beginning of any later fiscal year and it will then be taxed as an S corporation from the beginning of that fiscal year.<\/p>\n

For an in-depth discussion of each of the four ways an LLC can be taxed under the federal income tax law, read the article “How are LLCs Taxed?<\/a>” written by my son KEYTLaw attorney and former CPA Richard C. Keyt.<\/p>\n

7. AN OPERATING AGREEMENT IS NOT REQUIRED BY ARIZONA LLC LAW, BUT EVERY ARIZONA LLC INCLUDING SINGLE MEMBER LLCs SHOULD HAVE ONE
\n<\/strong><\/span><\/p>\n

Arizona law does not require the members of an LLC to sign an Operating Agreement.\u00a0 See “Protect Yourself: 20 Ways You Can Be Harmed if Your Arizona LLC Lacks a Well-Written Operating Agreement<\/a>.”<\/p>\n

An Operating Agreement is an agreement between the members and the LLC that sets forth the terms, conditions, rights and obligations agreed to by the parties with respect to the LLC. Every Operating Agreement should contain the following basic, but critically important provisions: (i) names and addresses of all members, (ii) percentage of the company owned by each member, (iii) each members\u2019 obligations, if any, to contribute money, property or services to the company, (iv) restrictions on transferring membership interests, (v) how new members can be admitted, (vi) situations that require approval of a majority of members or all members such as borrowing money, selling or buying land or entering into substantial contracts, and (vii) how members call meetings and vote on issues.<\/p>\n

If your LLC does not have a written Operating Agreement signed by all of the members, you have a time bomb waiting to explode. The following is a partial list of some of the nightmares that I have seen as an Arizona LLC lawyer and that could have been prevented if the members had signed a good Operating Agreement:<\/p>\n

a. Members disagree on who are members.<\/p>\n

b. Members disagree on the percentage of the company owned by the members. The Articles of Organization filed with the Arizona Corporation Commission does not state the percentage of the company each member owns. Without a written Operating Agreement signed by all of the members, how can you prove percentage ownership?<\/p>\n

c. One or more members agrees orally to contribute money or property or provide services, but does not do so. Arizona law provides that member of an Arizona LLC is not obligated to contribute money, property or services to the LLC unless the obligation is in a written document signed by the member.<\/p>\n

d. A member transfers all or a part of the member\u2019s membership interest in the LLC to a new and unwelcome person or entity without the knowledge or consent of the other members. Arizona law provides that members can freely transfer their membership interests unless restricted by a written agreement.<\/p>\n

e. One member causes the LLC to buy, sell, lease or incur an obligation without the prior knowledge or consent of the other members.<\/p>\n

A good Operating Agreement will eliminate or reduce problems and disputes among the members of a multi-member company.<\/p>\n

The most important reason why every LLC should have an Operating Agreement signed by all the members is to reduce the risk that a court pierces the company veil and holds the members liable for the debts of the LLC.\u00a0 One of the factors that courts take into consideration when asked to pierce the veil is did the members sign an Operating Agreement.\u00a0 If your LLC ever ends up in court you want to show that you operated your LLC like a business rather than a hobby.\u00a0 LLCs operated as businesses have signed Operating Agreements.\u00a0 LLCs operated as hobbies do not have Operating Agreements or minutes of meetings of the members and managers.<\/p>\n

How to Buy My Custom Arizona LLC Operating Agreement<\/strong><\/p>\n

Purchase my custom-drafted Operating Agreement that complies with Arizona’s new LLC law<\/a> that took effect September 1, 2019, by submitting my Operating Agreement Questionnaire<\/a>.\u00a0 I charge $297 for an Operating Agreement for a one owner company or a company owned only by a married couple.\u00a0 My fee for an Operating Agreement for a multi-member LLC other than an LLC owned by a married couple is $797.<\/p>\n

6. PURCHASE INSURANCE NAMING THE LLC AS AN INSURED<\/strong><\/span><\/p>\n

If your LLC will engage in business or own assets, including real property, be sure to purchase insurance coverage that is appropriate for the company\u2019s activities and property and for adequate coverage amounts.\u00a0 I recommend you consult with several business insurance agents and ask what types of insurance and what amounts of insurance the LLC should purchase and how much it will cost. \u00a0Important Fact<\/strong>: If your LLC suffers a loss and makes a claim on an insurance policy, the insurer will probably deny coverage unless the LLC is named as an insured on the policy.<\/p>\n

5. STATE OF FORMATION IS NOT RELATED TO STATE INCOME TAX LIABILITY<\/strong><\/span><\/p>\n

You may have heard radio ads or seen internet websites that invite you to form your LLC in Nevada and avoid paying state income tax. You should run from anybody that makes that claim because it is misleading. Whether an entity will owe state income tax has nothing to do with where the entity is formed. An LLC will owe state income tax if both of the following two conditions exist:<\/p>\n

a. the entity derives income from within a state, and<\/p>\n

b. the state from which the income is derived has a state income tax.<\/p>\n

For example, if you form an LLC in Nevada and the LLC owns rental real estate in Arizona that produces a gain from rental income, the Nevada LLC must report and pay Arizona state income tax. If you form an LLC in Arizona and its only source of income is derived in Nevada, the LLC will not have to pay Nevada income tax because it does not have a state income tax.<\/p>\n

4. DOCUMENT MEMBER AND MANAGER CHANGES<\/strong><\/span><\/p>\n

Not only is it important for all members and managers to sign an Operating Agreement when the company is formed, but it is equally as important to document changes with respect to members and managers. Over time, members may come and go or their percentage interest in the company may change. If the members do not document changes in a written document signed by the appropriate members, how will they be able to prove:<\/p>\n

a. When a new member was added.<\/p>\n

b. The new member\u2019s percentage interest in the company.<\/p>\n

c. The adjusted membership interests of the other members as a result of the transfer of membership interest to the new member.<\/p>\n

d. That a member terminated his, her or its membership interest in the company and the date of the termination.<\/p>\n

e. The terminating member releases the company from all claims the former member may have against the company and its members and managers.<\/p>\n

If you do not document changes, bad things can happen like nasty disputes that turn into a lawsuit. I actually had the members of an LLC that I formed in 1994 sue each other because, among other things, they could not agree on who the members were and what their percentage ownership was. I prepared a comprehensive Operating Agreement for the members in 1994, but they never signed it.<\/p>\n

Read my articles called “Requirements of Arizona Law to Become a Member\/Owner of an AZ LLC<\/a>” and “What to Do When Your LLC Adds or Deletes a Member or if a Member\u2019s Interest in the Company Changes<\/a>.”<\/p>\n

Hire Us to Document a Member Change<\/strong><\/p>\n

To hire us to document member or manager changes of an Arizona LLC submit our Member Change Questionnaire<\/a>.<\/p>\n

3. IF A MARRIED ARIZONA RESIDENT ACQUIRES AN LLC HE\/SHE OWNS IT AS COMMUNITY PROPERTY WITH THE OTHER SPOUSE<\/strong><\/span><\/p>\n

Arizona law provides that all property acquired during marriage by a spouse is the community property of both spouses.\u00a0This means that if a married Arizona resident acquires a membership interest in an LLC, Arizona law presumes that both spouses each own an undivided one-half of the entire membership interest as community property,\u00a0EVEN IF ONLY ONE SPOUSE IS NAMED IN THE ARTICLES OF ORGANIZATION AND\/OR THE OPERATING AGREEMENT<\/strong>.<\/span>\u00a0If a married person (the \u201cowner spouse\u201d) desires to own his or her membership interest in the company as separate property, the other spouse (the \u201cnonowner spouse\u201d) must sign a disclaimer by which the nonowner spouse disclaims owning any portion of the owner spouse\u2019s membership interest.<\/p>\n

If your goal is to own your interest in an Arizona LLC as separate property, you need to hire me to form your LLC because I will prepare a Disclaimer for your spouse to sign.\u00a0 Without this signed disclaimer, your spouse will automatically own one-half of your total ownership interest in the LLC.<\/strong><\/p>\n

To learn more about this issue see Arizona LLC attorney Richard Keyt’s article called “How Do I Acquire an Ownership Interest in an Arizona LLC as Separate Property?<\/a>”\u00a0 Protect yourself and preserve your separate property ownership of your LLC by purchasing Richard Keyt’s Disclaimer form for $47<\/a>.\u00a0 The Disclaimer is a downloadable fill in the blanks pdf file that you can edit and arrange for your spouse to sign if you want to own your LLC as your separate property.<\/p>\n

2. KEEP ALL INCOME AND EXPENSES SEPARATE<\/strong><\/span><\/p>\n

An Arizona LLC does not have as many legal formalities with which it must comply as an Arizona corporation, which is one of the reasons the LLC is the entity of choice in Arizona. The most important legal formalities that all LLCs must satisfy if the members want to defend against a creditor that is trying to pierce the company veil and hold the members liable are:<\/p>\n

a. If the LLC needs money, one or more members should first contribute money to the LLC by writing a check payable to the LLC and depositing it in the LLC\u2019s bank account. The LLC can then use the money to pay its expenses.<\/p>\n

b. Deposit all LLC revenue in the LLC\u2019s bank account<\/p>\n

c. Pay all LLC expenses from its bank account.<\/p>\n

d. Do not use LLC funds to pay expenses of members or managers or to benefit members or managers.<\/p>\n

e. If a member needs money for any purpose, the LLC can write a check to the member and designate the payment in the company\u2019s books as compensation for services rendered, a loan, or a return of capital. The member then deposits the money in the member\u2019s bank account and can use it for the member\u2019s needs.<\/p>\n

1. AN LLC DOES NOT PROTECT YOU FROM YOUR OWN MISCONDUCT<\/strong><\/span><\/p>\n

The primary reason to form an LLC is to protect the owners of the company from becoming liable for the business, real estate and activities of the LLC. If you operate a business or own real estate in your name rather than through an entity and anything goes wrong, you will be sued and all of your assets are potentially at risk. If you operate a business or own real estate through an LLC, the general rule of Arizona LLC law is that the members and managers of the LLC are not liable for the debts or obligations of the company.<\/p>\n

The general rule of no liability for the members and managers gives members and managers a great deal of asset protection and limited liability. There is, however, a huge exception to the general rule that all members and managers of an LLC (and corporations and other entities too) must know and understand. The exception is:<\/p>\n

MEMBERS AND MANAGERS ARE ALWAYS LIABLE FOR THEIR OWN ACTS AND OMISSIONS.<\/strong><\/span><\/p>\n

If you are on company business and run a red light in your car and kill or injure somebody, you will be sued because you ran the red light and the LLC will be sued because you were on company business. You cannot defend the lawsuit by saying you were merely working for the LLC when you caused the accident. If you are a manager and hire a guy to drive a truck for your business and he has two DUI convictions and a suspended license and he causes an accident that kills or injures somebody, the driver will be sued, the LLC will be sued and so will you because you were negligent in hiring the unqualified driver.<\/p>\n

Important Liability Fact of Life<\/strong>: Reduce the risk that you will be sued by eliminating or reducing your involvement with the LLC. For example, if your rental property needs to replace a gas water heater, hire a licensed plumber to do the job. If you do it and the gas explodes and kills or injures somebody, you will be sued.<\/p>\n

See my\u00a0graphic diagrams<\/a> that illustrate the bottom-up creditor problem and the top-down creditor problem.<\/span><\/p>\n

WHY YOU SHOULD HIRE ARIZONA LLC ATTORNEY RICHARD KEYT TO FORM YOUR AZ LLC<\/strong><\/p>\n

The primary reason I have formed\u00a010,000+\u00a0LLCs since 2001 is because nobody else provides the total LLC package that I provide at any price.\u00a0 Read the many testimonials from my happy LLC clients<\/a>.\u00a0 Another reason I form a ton of LLCs is because people love our formation services.\u00a0 See the contents and prices of our three LLC packages<\/a>.<\/p>\n

Watch the KEYTLaw Girl’s video in which she demonstrates what is contained in our LLC portfolio and get a glimpse of the high quality legal documents we customize for every LLC.<\/p>\n