Both limited liability companies and corporations are limited liability liability entities formed pursuant to state law.
A limited liability company, or LLC, is often characterized as a hybrid entity, a cross between a general partnership and a corporation, because it can possess attributes and characteristics associated with either type of entity, depending upon the desires of the LLC's owners.
Limiting Liability
All the partners in a general partnership1 are jointly and severally liable for all the debts of the partnership. In an LLC or a corporation, however, this is not the case: an owner of either an LLC or a corporation is only liable up to the amount of the owner's investment in the entity, subject to any misdeeds by that owner.
Corporations & Partnerships, Generally
Aside from limited laibility, perhaps the biggest differences between a general partnership — thus an llc — and a corporation are rooted in ownership and management. In particular, a general partnership exists automatically when two or more persons are engaged in a common business. In a general partnership, partners both own and manage the partnership. The owners of a corporation, however, may be passive investors in the corporation, may be involved in the management of the corporation, or both. Further, forming a corporation requires the satisfaction of various state filing and publication requirements.
Because partners are both owners and managers of a partnership, it is presumed that partners have a close working relationship and may share overlapping responsibilities in the operation of the business. This presumption carries over to the owners of an LLC and forms the basis for a significant distinction between LLCs and corporations: the charging order (discussed below).
Management
In Arizona, and in many other jurisdictions, an LLC can either be managed by "managers" or the owners of an LLC, which are called "members". Many, if not most, small businesses structured as LLCs opt to be managed by their members. Similar to a general partnership, in which each partner has full authority to manage and bind the partnership, each member in a member-managed LLC has full authority to bind and act on behalf of the LLC. This authority, however, can be limited or restricted if the members of an LLC execute an operating agreement that includes such restrictions.
Ownership Interest
Ownership of a corporation is, by default, quantified and evidenced by "shares" or "stock" in the corporation. As such, the owners of a corporation are called shareholders or stockholders. In contrast to a corporation, but similar to a partnership, an LLC doesn't issue shares or stock by default; rather, a member of an LLC is said to own a "membership interest" in the LLC. Sometimes, a membership interest is quantified by "units" or similar fictional constructs; more often than not, however, a membership interest is quantified through capital accounts or participation percentages. As a result, the owners of an LLC are often called members.
While a membership interest is, by default, freely transferable and alienable, an LLC can place restrictions on transferability of such interests in an operating agreement. Further, owning a membership interest in an LLC does not make the owner a member of that LLC. By default, an owner of a membership interest must be admitted as member of the LLC, subject to the consent of the other members of the LLC.
While a corporation, like an LLC, can place restrictions upon the transferability of stock in the corporation, such restrictions do not exist by default, at least not in Arizona. Further, shareholders of a corporation do not generally need to be admitted as shareholders, as is required for members of an LLC, because shareholders do not have full authority to bind and manage the LLC, as is often the case in a member-managed LLC.
Charging Order
Because of the foregoing, i.e. the presumption about the working relationships between LLC members and the restrictions and consents required to admit those who own membership interests as LLC members, a creditor of an LLC member is often limited to obtaining a charging order against an LLC member's interest in an LLC as opposed to foreclosing upon such interest, as can occur in a corporation.
In short, a charging order entitles the holder of the order to temporarily receive distributions from an entity in which a judgment debtor has an interest until the judgment has been satisfied. Holders of charging orders are not entitled to participate in management of the entity or compel distribution. For more information about charging orders, please see the following page on our site: Charging Order & Asset Protection.
Pursuant to Arizona law, a charging order is the exclusive creditor remedy as to an Arizona LLC member's membership interest in an LLC.
Taxation
Both corporations and LLCs can opt for "pass-through" taxation, which can minimize the tax associated with the profits of a business. However, LLCs are permitted greater flexibility in choosing the precise regime under which they will be taxed. A corporation can only select to be taxed under Subchapter C or Subchapter S of the Internal Revenue Code ("IRC"), while an LLC can select taxation under either Subchapter C, Subchapter S, or Subchapter K of the IRC. In addition, a single-member, i.e. one-owner LLC, can be taxed as a disregarded entity, which allows the LLC member to file a standard Form 1040 with a Schedule C, as opposed to filing a separate return for the LLC.
Formation
In Arizona, both LLCs and Corporation are formed by filing articles with Arizona's Corporation Committee. In the case of an LLC, it is said to be "organized" by filing articles of organization with the Corporation Commission, while a corporation is said to be "incorporated" by filing articles of incorporation with the Corporation Commission. In other states, these documents may have different names and may be filed with different government departments, e.g. the Secretary of State.
This brief overview of some important considerations associated with LLCs and corporations is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.
1There are various types of partnerships that provide limited liability to partners, such as limited partnerships, limited liability partnerships, and limited liability limited partnerships.
Douglas K Cook is an Arizona llc attorney with over 40 years of experience as a practicing attorney. Although Douglas K Cook's office is located in Mesa, Arizona, he represents clients throughout the Phoenix, Arizona Metropolitan area including the following east valley cities: Scottsdale, Paradise Valley, Tempe, Chandler, & Gilbert.
