Business Structures
The Right Form Can Help Your Business Function
There are many types of business organization in Arizona, but the most popular are Limited Liability Companies (LLCs), Corporations, and Professional Enterprises. The most important differences between these types of business in Arizona are their ownership and maintenance requirements, which are primarily determined by state law, and their tax implications, which are primarily determined by federal law.
In Arizona, if a business does not have a formal legal structure, the law creates a “default” structure. If the business is owned by one person, the default structure is a sole proprietorship, and if the business is owned by more than one person, the default structure is a general partnership. Sole proprietorships and general partnerships share several features. In both cases, the business is not legally distinct from the people who own the business and no documents are required to create or maintain a sole proprietorship or a general partnership. Because the business is effectively the same as its owner(s), all profits and losses of the business are passed directly on to the business owner. This also means that if the business incurs debts, judgments, or other obligations, those obligations are fully enforceable against the personal assets of the business owner(s). Partners in a partnership typically file a K-1, while sole proprietors file a Schedule C, but in both cases, the business does not pay its own taxes and instead the owners are taxed on the business’s income.
A corporation (the name is related to the Latin for ‘’body”) is legally a separate “person” from the people who own and manage it. It can take most of the same legal actions that human persons can, including owning property, entering into contracts, and filing lawsuits in court. Because it is separate from the shareholders, a properly formed and managed corporation offers the owners the advantage of “limited liability.” This means that no matter what happens to the company, a shareholder can never lose more than they chose to invest in the company because the shareholders are not responsible for debts or other liabilities that are incurred in the name of the corporation. The main downside of the corporation is that there are additional legal requirements for a corporation imposed by state law. For example, Arizona requires corporations to file a report each year with the Corporation Commission and to hold at least one meeting for shareholders per year in order to remain in existence. Arizona law requires corporations to adopt internal governing documents called “bylaws” which may impose additional or different requirements. Large corporations (with more than 100 shareholders) must be taxed as “C” corporations while smaller corporations can be taxed as “S” corporations. The most important difference is that a “C” corporation’s profits are taxed once to the corporation as an entity, then any payments to shareholders such as dividends are taxed separately to those owners. Generally, “S” corporations pass their income directly to shareholders and are taxed more like partnerships. There are several key exceptions to this rule, however, and so any specific tax questions should be addressed with a tax expert like a CPA. A corporation is also the most popular choice for people who wish to create a non-profit organization.
A limited liability company (LLC) offers the limited-liability advantages of a corporation but avoids most of the additional procedures and paperwork that a corporation requires. Like a corporation, the owners of a properly formed and managed LLC (“members”) are not responsible for the business’s obligations and do not stand to lose any more than they chose to invest. Unlike a corporation, an LLC is not generally required to have an annual meeting or to file an annual report. The LLC equivalent of a corporation’s bylaws is an “operating agreement.” Although it is not a legal requirement, adopting an operating agreement is often a good idea because under Arizona law, if an LLC does not have an agreement, the state will create one for that company with standard default terms and the owners will be required to abide by that agreement whether or not they specifically approved it. Because there is no specific tax category for limited liability companies in the Internal Revenue Code, LLCs can choose to be taxed like a corporation (most often, an S-corporation), or like a sole proprietorship or partnership (depending on whether it has one owner or several). The LLC structure offers owners the option to make a different choice about how the business will be taxed each year. Which option is most advantageous depends on the circumstances of the particular business and the ever-changing landscape of the tax laws, and is therefore a good topic to discuss with a tax advisor.
Arizona law also allows the creation of Professional Enterprises, which are special kinds of corporations and LLCs that are formed specifically to provide a professional service such as law, medicine, dentistry, accounting, etc. The rules for professional corporations and professional limited liability companies are similar in most ways to “regular” corporations and LLCs except that the state limits the ownership of a professional enterprise by people who are not members of that particular profession. Many professionals are required to run their businesses according to certain rules or procedures created by professional organizations, which could become a problem if a professional’s business were ever to become owned primarily by people who were not part of the professional organization. Setting up a business as a professional enterprise helps avoid this possibility by ensuring that the persons entitled to make key business decisions will always be members of the same profession (and therefore subject to the same rules) as the professionals who are carrying out the business’s primary function.
