What exactly is an LLC?

By Elizabeth Best

“LLC” stands for “limited liability company” and is a legal entity that, when set up and utilized correctly, will protect the individual owners from the company’s liabilities. LLCs are the most popular form of business entity in the United States. Each state has its own laws regarding LLCs but there are general characteristics that all LLCs have, including but not limited to:

  • Limited Liability Protection: The owners of an LLC, known as members, are typically not personally liable for the company’s debts and liabilities. This means their personal assets are protected in the event the business incurs debt or is sued. The LLC acts a shield to the owners’ personal assets. However, this protection can be compromised if the members engage in illegal or fraudulent activities, or if the members fail to maintain the corporate formalities of the LLC or keep the LLC separate from the members’ personally.
  • Flexible Management Structure: An LLC can be managed by its members (member-managed) or by appointed managers (manager-managed). This flexibility allows for varying degrees of involvement by the members in the day-to-day operations. LLCs can have an unlimited number of members, who can be individuals, corporations, other LLCs, and even foreign entities. There are no restrictions on the number and type of owners.
  • Ease of Formation and Compliance: Forming an LLC typically fewer formalities and paperwork compared to a corporation. In Arizona, an LLC is formed by filing Articles of Organization with the Arizona Corporation Commission and paying a filing fee. Nothing else is required to be a valid Arizona LLC (however, an operating agreement may be beneficial)
  • Operational Flexibility: LLCs have fewer regulatory requirements and formalities compared to corporations. In Arizona, LLCs are not required to hold annual meetings or maintain extensive records. However, best business practice would be to keep some records of the LLC’s business to show that it is operating separate and apart from the members individually.
  • Pass-Through Taxation: By default, LLCs do not pay federal income taxes at the business level. Instead, profits and losses are passed through to the members, who report this income on their personal tax returns. This avoids the double taxation that corporations face. An LLC can choose how it wants to be taxed. By default, single-member LLCs are taxed as sole proprietorships and multi-member LLCs as partnerships. However, they can also elect to be taxed as a corporation (either S corporation or C corporation) by filing the appropriate forms with the IRS.

LLCs can be used for a wide variety of businesses, including but not limited to:

  • Small businesses
  • Medium-sized businesses
  • Startups
  • Real estate investments
  • Real estate rentals
  • Professional firms (such as law or accounting practices)
  • Joint ventures
  • Family businesses

If an LLC is not set up or utilized correctly, you run the risk of the other party being able to “pierce the corporate veil”, which is a legal concept used to hold the owners/ members of an LLC personally liable for the entity’s debts and obligations. This doctrine is typically invoked in situations where the corporate entity is used to perpetrate fraud, commit wrongful acts, or when the separation between the entity and its owners is blurred

Common mistakes people make with LLCs that can result in Piercing the Veil:

  • Commingling of Funds (the LLC should have its own separate bank account used only for the business purposes of the LLC)
  • Executing Contracts Personally Instead of On Behalf of the LLC (if the LLC is a party on a contract, then you should sign on behalf of the LLC and not as yourself individually)
  • Failure to Adequately Capitalize the LLC (members formed the LLC without providing enough capital to carry out its normal business operations and meet its reasonably anticipated obligations)
  • Business Assets used by members for personal purposes (company car shouldn’t be used for road trip to Vegas)
  • Business funds used to pay personal debts

An LLC provides a flexible and protective structure for businesses, offering a blend of liability protection, tax benefits, and operational flexibility. If you are looking to start a business in Arizona, meeting with one of our business attorneys is a great place to start, as we can determine whether an LLC makes the most sense for your business.