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Top 5 Dos and Don’ts of Hiring and Managing Subcontractors

Protect your construction business’ profits by reducing legal liabilities

Elena Vega

Business is better than ever? Great! But it’s also a good time to check your company’s legal compliance regarding subcontractors. Why? Because just one subcontractor with a legitimate complaint and a good attorney can spell financial ruin for your construction business. Here we’ll share how to safeguard your hard-earned profits by making sure you and your subcontractors are legally compliant.

A Bit of Backstory

Using subcontractors has been standard practice for decades in the construction industry. But there’s been a strong push in recent years to eliminate 1099 contractors, regardless of how many or few hours they work, based on the idea that they’re unfairly losing out on benefits, overtime pay, worker’s compensation and more. And if any of your subcontractors decide that they actually should have been classified as W2 employees, and a judge agrees, you could have to fork over back payroll taxes, worker’s comp claims, retirement benefits, overtime pay, and attorney’s fees pronto — plus fines on top of all that.

D.S. Berenson, managing partner of the Berenson law firm LLP, which has an exclusive practice in remodeling and home improvement law and represents the majority of the top 500 remodelers nationwide, calls this a “nuclear risk,” saying: “One guy and you could easily be facing a $100,000 bill right away. If you get hit with this, it’s nuclear.”

He advocates creating a “brick wall of protection.” Some elements of that brick wall relate to other aspects of a construction business, such as adding contingency clauses for delays and price changes in client contracts, and following lead-paint laws to the letter. But here we’ll discuss only those related to subcontractors. Now on to the five dos and don’ts.

1. DO have a written agreement with subcontractors in place.

The first step in creating what Berenson calls a “brick wall of protection” against reclassification cases (when 1099 workers believe they should be W2) is to have a written agreement with all your subcontractors in place. And this applies no matter how small the job or how well you know the subcontractor. If you don’t have a signed agreement, “you’re going to lose a reclassification audit right off the bat,” Berenson says.

According to Construction Executive, the agreement should include at a minimum the subcontractor’s licensure, scope of work, payment terms and a section covering defense and indemnification of the contractor by the subcontractor in the event of any lawsuits or misrepresentations. Consult an attorney experienced in home improvement law for more details.

2. DON’T hire individuals — hire companies.

Any subcontractor you hire should be an independent business entity (an LLC or other type) and should have a tax identification number, also called an employer identification number, or EIN. “Do not hire the individual,” Berenson advises. Hiring a company with its own EIN protects you against any W2 reclassification claim, as companies cannot be employees. Keep in mind that a company can be a sole proprietorship, meaning composed of only one person.

While you’re onboarding subcontractors, it’s a terrific idea to get a copy of the cover page from one of their federal or state tax returns. If they’ve worked even one job, it will show that they’ve been taking deductions as a business — for tools, vehicles and so on. If any subcontractors later claim they should have been employees, it means they’ve committed tax fraud by lying on their tax returns. Having that tax-return page is “our silver bullet,” Berenson says. “You’d be surprised how magically the reclassification case disappears.”

3. DO make sure they’re licensed and tech-savvy.

If you’re in one of the roughly 38 states that require general contractors to be state-licensed, your subcontractors must be licensed as well. Consider not just licensing but bonding and any special certifications the job or client requires. Make sure this is all included in the written agreement.

Consider also whether or not the subcontractor uses modern technologies and digital tools rather than outdated manual versions. Not only do many clients expect digital tools these days, but they’ll make any building or remodeling project go more smoothly. One popular software platform that many builders use is Houzz Pro, which has tools to make collaborating with subcontractors easier. They get free access and can see only what you share with them, such as daily project logs, timelines and task lists. It also has a time and expense tracker for team members to make quick work of billing.

4. DON’T ignore other little legal details.

Consulting an attorney specializing in the construction industry is an excellent idea, as it’s easy to overlook little legalities. For instance:

  1. You must pay your subcontractors by the job.
  2. They must have the ability to work for others, even if they don’t actually do so. They should show this by having a business website, business cards, business stationery for invoicing and the like.
  3. You must file a 1099-MISC form with the IRS for each subcontractor.

Also know that having a mixed base of 1099 and W2 subcontractors is a red flag and very risky, Berenson says. As part of your brick wall of protection, you should have only one or the other.

5. DO communicate regularly — and respectfully.

While you’re dotting all the i’s and crossing all the t’s, It’s important to remember that even if they’re officially businesses, subcontractors are people too. And collaborating well with them is key not just to successfully completing any construction project but to ensuring that they feel well treated and will want to work with you again.

Communicating openly, regularly, and professionally with them is a great way to make sure you’re always on the same page, whether it’s about legal compliance, project details or job satisfaction. This is another area where Houzz Pro can support your business, thanks to its tool for managing project-related communication among team members. And since it’s cloud-based, you and your subcontractors can stay in touch from job sites or on the go.

By taking the above measures and consulting a legal pro, you’ll be well on your way to enjoying your revenues without worrying about any subcontractors taking advantage of your good fortune.

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Elena Vega has been writing and editing for more than 20 years. Word games fan. Adoring mom. New York native calling San Francisco home.

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