This article is written by Arizona LLC attorneys Richard Keyt and his son Richard C. Keyt who have drafted 9,300+ LLC Operating Agreements.  They have 252 five star Google reviews and 372 five star online reviews.

The article explains the 20 ways owners of Arizona LLCs can be harmed if their LLC doesn’t have a comprehensive well written Operating Agreement signed by all of the members.  Arizona LLC law does not require Arizona LLCs or PLLCs to have an Operating Agreement, but these two Arizona LLC attorneys recommend that the members of ALL Arizona companies sign an Operating Agreement that eliminates all of the 20 harms described below.

What is an LLC Operating Agreement?

An LLC Operating Agreement is a contract between the LLC and all of its owners (called members) and managers (if the LLC is manager managed) that names all members and managers, the percentage of the LLC that each member owns, if a member is required to contribute money or property to the LLC, how meetings are called and when action cannot be taken without the approval of a majority or a super majority of the members or all of the members.  The Operating Agreement sets the rules for governing the LLC.

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20 Ways You Can be Harmed if Your AZ LLC Lacks a Well Written Operating Agreement

If an Arizona LLC does not have an Operating Agreement signed by all of its members that contains provisions that alter Arizona LLC law then Arizona’s LLC statutes govern the LLC and its members.  The reason you want your Arizona LLC to have a well written Operating Agreement is to eliminate the negative provisions in Arizona’s LLC statutes described in the 20 harms below.

If you buy our comprehensive Operating Agreement it will eliminate all of the harms described below.  To hire us to prepare your custom Operating Agreement complete and submit our online Operating Agreement questionnaire.

Click on a + symbol or blue text to open the text box and read the info inside the text box.

Ned Flanders contributed $90,000 to the LLC and Homer and Marge Simpson contributed $10,000.  Ned incorrectly assumes that if the LLC distributes $10,000 then he will get 90% ($9,000) and the Simpsons will get 10% ($1,000).  Wrong!

Arizona Revised Statutes Section 29-3404.A states: “Any distribution made by a limited liability company . . . must be in equal shares among Members.”  There are three members so each gets one third of the distributions.  This means that Ned gets $3,333 and the Simpsons get $6,667.  This  statute can be eliminated by an Operating Agreement that states how distributions will be allocated to all of the members.

Arizona Revised Statutes Section 29-3105.A.3 states: “in the event of a conflict between a provision of the operating agreement and this Chapter, the provision of the operating agreement governs.”  This statute gives members of an Arizona LLC to override Arizona LLC law and allocate distributions as stated in the Operating Agreement rather than equally.

If you don’t want your LLC to make equal distributions of money to the members then the members must sign an Operating Agreement that states how distributions will be allocated among the members.  Ned needs to convince the Simpsons to sign an Operating Agreement that says Ned gets 90% of the distributions and the Simpsons get 10%.

Ned Flanders contributed $90,000 to the LLC and Homer and Marge Simpson contributed $10,000.  Ned incorrectly assumes that the LLC’s profits will be allocated 90% to him and 10% to the Simpsons.  Without an Operating Agreement Ned will be allocated 1/3 of the profits and the Simpsons will be allocated 2/3 of the profits.  Ned thinks that if the LLC has profits of $90,000 he will be allocated $81,000 and the Simpsons will be allocated $9,000. Wrong!  The actual allocation of profits is $30,000 to Ned and $60,000 to the Simpsons.

Arizona Revised Statutes Section 29-3102.12 states: “’Members’ respective interests in the Company’s profits are in proportion to their rights to share distributions.” Arizona Revised Statutes Section 29-3404.A requires that distributions to members be equal.  If Ned Flanders owns 90% of the LLC and Homer and Marge Simpson own 10% they will share the profits equally unless they have an Operating Agreement that provides Ned gets 90% of the distributions and profits and the Simpsons get 10%.  If the LLC has a profit of $90,000 and the LLC’s Members have not signed an Operating Agreement that states how the profits are allocated, then $30,000 will be allocated to Ned and $60,000 will be allocated to Homer and Marge.  If you don’t want your LLC to allocate its profits to the members equally the members must sign an Operating Agreement that states how distributions and profits will be allocated.

Arizona Revised Statutes Section 29-3105.A.3 states: “in the event of a conflict between a provision of the operating agreement and this Chapter, the provision of the operating agreement governs.”  This statute gives members of an Arizona LLC to override Arizona LLC law and allocate profits other than based on distributions.

Ned Flanders, Homer Simpson and Marge Simpson are the three members of an Arizona LLC.  Because they did not sign an Operating Agreement the LLC’s profits are allocated one third to Ned, one third to Homer Simpson and one third to Marge Simpson.  See Harm 4 above.

Arizona Revised Statutes Section 29-3102.12 states: “‘Majority in Interest of the Members’ means . . . one or more Members that hold in the aggregate a majority of the interests in the limited liability company’s profits.”

This means each member gets one vote because the profits are allocated equally.  Thus the Simpsons have two votes and Ned has one vote.  The Simpsons have voting control of the LLC despite contributing $10,000 to the LLC versus Ned Flanders’ contribution of $90,000.

If you don’t want each member of your company to have one vote instead of members having the number of votes equal to their percentage interest in your LLC the members must sign an Operating Agreement that states how many votes each member gets.

Arizona Revised Statutes Section 29-3105.A.3 states: “in the event of a conflict between a provision of the operating agreement and this Chapter, the provision of the operating agreement governs.”  This statute gives members of an Arizona LLC to override Arizona LLC law and state how many votes are allocated to each member.

Arizona Revised Statutes Section 29-3201.B.4 states that the Articles of Organization must name: (i) all members of a member managed LLC, or (ii) all members who own twenty percent or more of the capital or profits of a manager managed company.  It is very common for an LLC’s Articles of Organization to omit one or more members because the organizer did not know about Section 29-3201.  Does your LLC’s Articles of Organization satisfy this requirement?  If not, it needs to amend its Articles of Organization to add any missing members. To amend your Arizona LLC’s Articles of Organization complete our amendment questionnaire.

Many people and institutions know that an LLC’s Articles of Organization may not correctly name all members.  The only way to prove who owns the LLC is by an Operating Agreement signed by all of the members.  Operating Agreements are required by: (1) some banks to open a bank account, (2) lenders before making a loan, (3) title insurance companies when an LLC buys or sells land, (4) third parties before entering into a substantial contract with the LLC, and (5) courts when the members litigate.

When an Arizona LLC is formed the Arizona Corporation Commission’s Articles of Organization does not state the percentage of the company owned by each member.  Arizona LLC law does not require the percentage of the company owned by the members be stated in the Articles of Organization.  The only way to prove the percentage of the company owned by each member is by an Operating Agreement signed by all of the members.

You can see in this filed Articles of Organization that no ownership percentage is stated:

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If you are a married Arizona resident and you want the LLC membership interest of the first spouse to die to transfer automatically to the surviving spouse without the need for an expensive and time-consuming Superior Court probate then you and your spouse must own your membership interest as community property with right of survivorship, not as community property.

If you are a married Arizona resident who owns an Arizona LLC with your spouse as community property, not as community property with right of survivorship, then the membership interest of a deceased spouse does not automatically transfer to the surviving spouse and only the half interest of the deceased spouse gets to increase its tax basis.

Warning for Arizona Residents

The State of Arizona has a law that determines who inherits the assets of people who die without a will or a trust. This law may cause your membership interest and other assets to be inherited by the wrong person or people. To learn who will inherit your LLC and other assets if you lack a will or trust see my article called Who Inherits Your Property If You Die without a Will or a Trust and take my short online quiz called Who Inherits Your Property. If the wrong person or people would inherit your membership interest or other assets the solution is for you to hire us to prepare a will or a trust that leaves your assets to the person or people you want to inherit the assets.

If you are a married Arizona resident and have a child who is not your spouse’s child (i) one half of your separate property goes to your surviving spouse, and (ii) one half of your separate property and your entire one half interest in community property with your spouse passes to equally to your children.  For example if Dick and Jane own their home as community property and Dick has a son Bob who is not Jane’s child then if Dick dies, his community property interest in the home goes entirely to his son Bob and Jane gets none of the home.  If Dick and Jane own their home as community property with right of survivorship and one of them dies the other automatically inherits the deceased spouse’s one half interest in the home without the need for a probate.

How to Own Your LLC as Community Property with Right of Survivorship

Arizona Revised Statutes Section 29-3401.G states “An estate in community property with right of survivorship is created when a written operating agreement expressly declares that a married couple holds a transferable interest as community property with right of survivorship.” If the married Arizona residents do not sign an Operating Agreement with the required language they will own the LLC as community property, not CPWROS, which means that if a spouse dies an expensive probate may be necessary to transfer ownership of the LLC to the surviving spouse and the surviving spouse may not inherit the interest of the deceased spouse if the deceased spouse has any children who are not also children of the surviving spouse.

The three ways married Arizona residents can own their LLC are:

  • Community property. This is the default ownership when a married Arizona resident forms an LLC. Arizona law provides that when a married Arizona resident forms an Arizona LLC or PLLC both spouses automatically own the entity as community property. When a married couple owns their entity as community property and one spouse dies the interest of the deceased spouse may not automatically pass to the surviving spouse and may have to go through an expensive and time-consuming Superior Court probate. Also, the surviving spouse may not inherit the interest of the deceased spouse. See the Warning below.
  • Community Property with Right of Survivorship. When a married couple are residents of Arizona and they own their LLC or PLLC as community property with right of survivorship (CPWROS) then if one spouse dies the surviving spouse automatically becomes the owner of the membership interest of the deceased spouse without the need for a probate. If you are a married Arizona resident and want the surviving spouse to automatically inherit the membership interest of the deceased spouse then both of you must own your membership interest as CPWROS, not as community property.
  • Separate Property. This is property owned 100% by one spouse and 0% by the other spouse. Separate property is any property acquired by an Arizona resident before marriage or property received by a married Arizona resident receives the property as a gift or from an inheritance. It is also created when one spouse signs a disclaimer in which the non-owner spouse admits that the other spouse owns all of the asset. If you are an Arizona resident who formed an while married, your spouse automatically owns 1/2 of your interest with you as community property unless you get your spouse to sign a Disclaimer. Purchase our editable Disclaimer form for $47.

Sale of the LLC After Death When Owned as Community Property

You and your spouse own 100% of World Wide Widgets, LLC as community property, not community property with right of survivorship.  You formed the LLC for $10,000.  This is your tax basis, which means that if you sell the company for $1,000,000 you have a capital gain of $990,000 ($1,000,000 sales price – $10,000 tax basis).  In 2023, you won’t pay any capital gains tax if your total taxable income is $89,250 or less if you file a joint tax return. The rate jumps to 15% of capital gains if your income is $89,251 – $553,850 if you file a joint tax return. If your income is above $553,850 the rate is 20% if you file a joint tax return.  The 20% capital gains tax on the capital gain following the sale of the LLC for $990,000 is $198,000.

Using the above facts if you were to die owning the LLC as community property with your spouse and your spouse inherits your one half interest in the LLC after a probate then your spouse’s tax basis in the LLC is $5,000 + $500,000 = $505,000. Your one half interest in the LLC gets a stepped up tax basis equal to the fair market value of your one half interest in the LLC as of your date of death.  Now when your spouse sells the LLC shortly after your death her capital gain is $1,000,000 sales price – $505,000 tax basis  = $495,000.  Your spouse’s capital gains tax is 20% of $495,000 = $99,000.

Sale of the LLC After Death When Owned as Community Property with Right of Survivorship

Using the above facts if you were to die owning the LLC as community property with right of survivorship then two important events occur.  These two events would not occur if you own the LLC interest as community property.  The two events are:

  1. Your spouse automatically inherits your half interest in the LLC without the need for a probate, and
  2. Your spouse’s tax basis in the LLC is equal to the fair market value of the company on your date of death.

Now if your spouse sells the LLC for $1,000,000 with a tax basis of $1,000,000 there is no capital gain, which means your spouse saved the $99,000 capital gains tax that would have been owed if you owned the LLC as community property instead of community property with right of survivorship.

Lesson

Married Arizona residents should always own their assets as community property with right of survivorship unless one spouse wants to own any assets as separate property.  Married Arizona residents who own their interest in an LLC as community property with right of survivorship can save a tremendous amount of taxes after the death of a spouse if the surviving spouse sells the interest in the LLC.  In the example above the surviving spouse saved $99,000 in capital gains tax because the LLC interest was owned as community property with right of survivorship. The only way married Arizona residents can own their interest in an LLC as community property with right of survivorship is if they sign an Operating Agreement that states they own their interest as community property with right of survivorship.

How to Own Your LLC as Community Property with Right of Survivorship

Arizona Revised Statutes Section 29-3401.G states “An estate in community property with right of survivorship is created when a written operating agreement expressly declares that a married couple holds a transferable interest as community property with right of survivorship.” If the couple does not sign an Operating Agreement with the required language they will own the LLC as community property, not CPWROS, which means that if a spouse dies the surviving spouse does not get to step up the tax basis of the entire interest in the LLC to its fair market value on the date of death of the first spouse to die.

Arizona Revised Statutes Section 25-211.A  states: “All property acquired by either husband or wife during the marriage is the community property of the husband and wife except for property that is . . . Acquired by gift, devise or descent.”  This statute means that if only one of you is named as a member in an LLC’s Articles of Organization the named person owns his or her share of the LLC as community property, not as separate property.

Arizona Revised Statutes Section 29-3205.C states: “An individual who signs [Articles of Organization] affirms under penalty of perjury that, to that individual’s knowledge, the information stated in the record is accurate.”  Thus if you are a married Arizona resident who formed an Arizona LLC that did not name you and your spouse as members of the LLC you have this statute hanging over your head because you did not acquire your interest in the LLC as a gift or from an inheritance when you formed the LLC.

If you need to amend your LLC’s Articles of Organization to add a missing spouse we can amend your Arizona LLC’s Articles of Organization for $195 + a $60 Arizona Corporation Commission filing fee.  To hire us complete our amendment questionnaire.

Arizona Revised Statutes Section 25-211.A states “All property acquired by either husband or wife during the marriage is the community property of the husband and wife except for property that is . . . Acquired by gift, devise or descent.”  This means that all married Arizona residents who form an LLC will own the LLC as community property with their spouse, not separate property, even if the other spouse is not named as a member in the LLC’s Articles of Organization filed with the Arizona Corporation Commission.  If you are a married Arizona resident and you want to own your interest in the LLC as your separate property, your spouse must sign a disclaimer whereby the non-owner spouse disclaims any and all interest in the LLC.

When we prepare an Operating Agreement and if any member who is a a married Arizona resident wants to own his or her interest in the LLC as separate property we prepare a Disclaimer for the non-owner spouse to sign.

If you want your significant other to automatically inherit your interest in an LLC that person will not inherit your interest in the LLC unless:

  1. you have a last will and testament or a trust that gives it to him or her, or
  2. each of you owns the LLC as joint tenants with right of survivorship (“JTWROS”).

If you own your LLC interest with your significant other as JTWROS and you die your significant other will automatically inherit your interest in the LLC without the need for an expensive probate.  If your significant other dies first you will automatically inherit that his or her interest in the LLC.

Arizona Revised Statutes Section 29-3401.F states “A joint tenancy with right of survivorship is created when a written operating agreement expressly declares that two or more natural persons hold a transferable interest as joint tenants with right of survivorship.”  If you hire us to prepare your Operating Agreement and you want to own your interest in the LLC as JTWROS with another person we will insert language in the Operating Agreement that causes you and the other person to own your interest in the LLC as JTWROS.

If your LLC’s Articles of Organization filed with the Arizona Corporation Commission states the LLC is manager managed and names one or more managers you will be surprised to learn that none of the named managers is actually a manager who holds management powers unless the LLC has an Operating Agreement that names its manager(s).  Arizona Revised Statutes Section 29-3102.13 states: “’Manager’ means a person that under the Operating Agreement of a manager-managed limited liability company is responsible, alone or in concert with others, for performing the management functions.” All Operating Agreements we prepare for manager managed LLCs name the manager(s) who also sign the Operating Agreement.

You are a member of a five member LLC that is member managed.  Homer Simpson is another member.  Without the knowledge or consent of the other members Homer causes the LLC to enter into a $100,000 employment agreement with Homer’s son-in-law Bob.  If Homer is the manager of the LLC he can do the same thing.  Members of a member managed LLC and managers of a manager managed LLC have virtually no limitations on what they can do on behalf of the LLC.  Your multi-member LLC must have language in its Operating Agreement that states what members and managers can do without member approval and what they can do only after getting member approval.

Arizona Revised Statute Section 29-3407 states “In a member-managed limited liability company . . . each member has the right to manage and conduct the company’s activities and affairs.”  It also states “In a manager-managed limited liability company . . . the right to manage the company is vested in the manager or managers.”  This statute does require the approval of members or managers with respect to some matters, but it does not require member approval with respect to any actions that are within the scope of the company’s purpose.

One of the most important reasons for the members to sign an Operating Agreement is to limit the ability of members and managers to take major actions without the prior approval of the members.  Homer should not be able to enter in the $100,000 employment agreement with his son unless the members vote to authorize the agreement.  Do not let members or managers of your LLC have virtually unlimited power.

Our multi-member Operating Agreements contain a list of major actions that a member or manager cannot take with the approval of a majority of the members.  You can also require that some actions require a super majority approval or approval of all members.

The IRS rules say that multi-member LLCs are taxed as partnerships under federal income tax law.  This means your multi-member LLC will be taxed as a partnership unless it elects to be taxed as an S corporation by filing IRS form 2553 or a C corporation by filing IRS form 8832.  If your LLC is taxed as a partnership the members need must sign an Operating Agreement that designates a member of the LLC or a trusted person such as the LLC’s tax accountant to be the LLC’s partnership representative.

Your LLC’s partnership representative has the sole authority to deal with the IRS on behalf of the LLC and all of its members with respect to the following matters:

  • settling a tax audit,
  • agreeing to a final partnership tax adjustment,
  • making an Internal Revenue Code Section 6226 election to pay a partnership liability at the partner level, and
  • agreeing to a Section 6235 extension of the period for making partnership adjustments.

If your LLC is taxed as a partnership and it does not designate a partnership representative the IRS may name your LLC’s partnership representative. If the IRS appoints your LLC’s partnership representative because it is auditing the LLC do you think it will appoint somebody who will look out for the LLC’s members or will the IRS designated partnership representative look out for the IRS’ interest?  Your LLC’s partnership representative is the only person the IRS will talk to and deal with if it audits your LLC.  This means that if the IRS says your LLC owes $50,000 in back taxes and your IRS appointed partnership representative agrees your LLC will become obligated to pay the IRS $50,000 and the members cannot object.

If your LLC is taxed as a partnerships it must have an Operating Agreement that names a member or a trusted person to be the LLC’s partnership representative to prevent the IRS from naming your LLC’s partnership representative.  The Operating Agreement should also require the LLC’s partnership representative to get the approval of the members before the partnership representative can approve any IRS action that would adversely affect the members such as agreeing that back taxes are owed.

Our Operating Agreements designate the LLC’s partnership representative and have three pages of text that sets out the partnership representative’s obligations to the LLC.

A man called me once and said his restaurant’s video surveillance system caught one of the members of the LLC stealing cash from a cash register.  He asked if the LLC could expel the thief.  His LLC had an Operating Agreement, but it was silent with respect to what would happen if a member stole assets from the LLC.  Because the LLC’s Operating Agreement was silent about theft, the man was stuck with the thief.

Our Operating Agreements contain a provision that provides that if a member steals money or property from the company the following applies:

  • the thief is in default of the Operating Agreement;
  • the thief is liable to all the other members for the greater of actual damages suffered by each other member or liquidated damages of $10,000 plus any legal fees the other member pays or incurs as a result of the theft or embezzlement and in collecting the damages;
  • the thief cannot vote on any matter on which the other members vote; and
  • the other members shall have the option for one year after the discovery of the theft to purchase the entire membership Interest of the thief for $100.

You do not want to be “partners” indefinitely with a thief.  You need an Operating Agreement like ours that gives you the ability to buy out a thief for $100 and rid your LLC of the cancer.

You and Homer Simpson are the only two members of an Arizona LLC.  Homer calls you and says he transferred his entire interest in the LLC to Ned Flanders, a man you can’t get along with.  Because the LLC does not have an Operating Agreement that requires all members must consent to a transfer of a membership interest Homer is stuck and is now “partners” with a man he can’t stand.  If you don’t have a well written Operating Agreement that prohibits transfers without approval of the members then any member can transfer all or part of their membership interest to any third party.

Arizona Revised Statutes Section 29-3502.A states “A transfer, in whole or in part, of a transferable interest . . . is permissible.”  Our Operating Agreements require the prior approval of the members to transfer all or part of a membership interest.  Approved transfers also require that other conditions must be met such as the new member must sign the LLC’s Operating Agreement and reimburse the LLC for any expenses it incurs because of the transfer.

Arizona Revised Statutes Section 29-3403.A states “A person’s obligation to make a contribution to a limited liability company is not enforceable unless the obligation is set forth in a record signed by the person.”  If you want a member to be legally obligated to contribute money, property or services to your LLC that member must sign a “record” such as an Operating Agreement in which the obligation to contribute is stated.

Our Operating Agreements contain language that requires members to contribute money, property or services if you tell us what each member is required to contribute.

Arizona Revised Statutes Section 29-3407.G states: “A member is not entitled to remuneration for services performed for a member-managed limited liability company.”  If you want your member managed LLC to pay you for services you must sign an Operating Agreement that authorizes the LLC to pay you for services.

If the members don’t sign an Operating Agreement that states there are no oral agreements between the members and oral agreements will not be enforced then one or more members may claim the members agreed orally to do something.  The lack of an Operating Agreement leads to he said she said disputes and expensive litigation.  My first year contracts professor said and it is true today: “If it isn’t in writing, its like it never happened.”

If you are the sole manager of your manager managed LLC and you die or become mentally incompetent your company does not have a manager who can run the company.  See Harm 11: Arizona law says managers must be named in an Operating Agreement.  This could harm the company until a replacement manager is appointed by the members.  Our Operating Agreement can provide that if your manager dies or becomes mentally incompetent the person or people designated in the Operating Agreement as replacement manager(s) automatically become the manager(s).  The replacement manager can immediately file an amendment to the LLC’s Articles of Organization with the Arizona Corporation Commission to name the new manager.

A federal law called the Corporate Transparency Act (CTA) became effective on January 1, 2022.  The CTA requires every “reporting company” (almost all LLCs, for profit corporations and similar entities are reporting companies) to file a report with the U.S. Financial Crimes Enforcement Network (FinCen).  Reporting companies created or registered before January 1, 2024, will have until January 1, 2025, to file their initial reports.  Reporting companies created or registered after January 1, 2024, will have 30 days after receiving notice of their creation or registration to file their initial reports.  Companies that do not file a timely report are subject to a $500/day fine.

Reporting companies must disclose to FinCEN the required information about each beneficial owner.  A beneficial owner is an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise (i) exercises substantial control over the entity; or (ii) owns or controls not less than 25 percent of the ownership interests of the entity.  See the definition of beneficial owner.

The following is the required information about each beneficial owner that the reporting company must disclose to FinCEN: (i) full legal name, (ii) date of birth, (iii) the beneficial owner’s residential or business street address as of the date the report is delivered to FinCEN; and (iv) the unique identifying number from the beneficial owner’s acceptable identification document or the beneficial owner’s FinCEN identifier number.  See the definition of beneficial owner.

Your LLC’s Operating Agreement must have language that requires members to disclose the above information to the company and provide that members who fail to file the required information will reimburse the LLC for any fines it may suffer because of the failure to provide the information.  Our Operating Agreements have this language.

Hire Us to Prepare a  Custom Arizona LLC Operating Agreement

We want to prepare a custom Operating Agreement for your company for $297 (single member and married couple LLCs) or $797 (multi-member LLCs).  To hire us complete our online Operating Agreement questionnaire.  We will send an email to all members that has the Operating Agreement attached so each member can digitally sign the OA using DocuSign.  When all members have signed DocuSign will send an email to all members that has the fully signed Operating Agreement attached.