When choosing a type of business entity for their business, general contractors should think about the legal, financial and tax implications. How can you help your customers to be better informed about the type of business entity that could be of most benefit to them?
Below, I’ll share six key considerations as they explore the options available. Naturally, I encourage you to offer the expertise and advice that you are authorized to give them in this matter. And if they seek legal advice, recommend that they speak to a reputable lawyer who can assess their situation and give them direction.
1. Liability risks
Contractors in the construction, home improvement and renovation industries face various liability risks related to customers and employees (e.g. personal injury, property damage, negligence, project delays, etc. ). While general contractors may be attracted to the administrative simplicity of operating as a sole proprietorship or partnership, these business structures provide no legal separation between the business owner and the business. If someone sues the business, it puts the personal property of the business owner at risk.
So, general contractors can consider reassuring themselves by setting up a limited liability company or a C company instead. Both structures are their own legal entities – independent of their owners – and therefore offer entrepreneurs civil liability protection.
2. Tax matters
As you know, sole proprietorships, partnerships and limited liability companies are one and the same as their owners for income tax purposes. While the intermediary entity tax treatment is practical and relatively simple, it is not always financially ideal. This self-employment tax burden can hurt!
With this in mind, general contractors may wish to discuss the choice of tax treatment for S corporations. For some clients, incorporating as a C corporation (or being an LLC that chooses to be taxed as a C corporation) may be advantageous. (based on the business owner’s personal tax rates versus corporate rates and other factors). Your customers may need your help figuring out the numbers and figuring out what will be best. Doing the math can help make an informed decision your customers can count on!
3. Compliance formalities
Entity related compliance. General contractors may benefit from minimum compliance responsibilities when operating as a sole proprietorship or partnership. There are generally no state entity registration documents or pending compliance filings required other than filing (and renewing) a DBA (if the business uses a fictitious name), filing taxes and the application (and renewal) of business licenses.
LLCs need to follow more compliance rules. However, they are generally not extensive, too long, or expensive. Several common LLC business compliance requirements include obtaining an employer identification number, maintaining a registered agent, holding an annual meeting of members, and submitting an annual report.
C companies have the most responsibility for compliance. Among them, the holding of meetings of shareholders and the board of directors, record the minutes of these meetings, maintaining bylaws and filing annual reports (in most states).
Requirements vary from state to state, so it may be beneficial for your clients to seek advice from a legal professional to ensure they understand their obligations.
Industry-related compliance. Regardless of the type of entity, there are often other requirements that general contractors will need to meet in order to do business legally:
- Licenses and permits. General contractors must obtain all national and local business licenses and permits they will need to operate legally. Additionally, if they are managing a team of contractors or sub-contractors, they should check that all people and entities working for them have the proper business licenses, permits and tax forms. Otherwise, they could incur fines and other penalties. The Customer State Business Licensing Board is a good resource for identifying requirements. Your customers can find links to state licensing agencies on the SBA website. Several industry-specific licenses that a contracting company may need include a lead-based paint certification, a contractor’s license, or a specialty contractor’s license.
- Business insurance and surety bonds. In many states, contractors are required to have general liability insurance and bonding to protect themselves and their clients. When pricing commercial insurance, your customers may find that they can get cheaper rates if their business is registered as an LLC or corporation. Why? Keep in mind that sole proprietorships and partnerships are the same legal entity as their owners and may be considered riskier, as personal property could be tied up in resolving legal claims against the business. Something to note about bonds – sometimes the bond amounts required for general contractors incorporated can be much higher than the bond amounts for general contractors incorporated.
Remind your customers that obligations can vary from local jurisdiction to local jurisdiction and state to state. It is worth taking the time to study the requirements carefully!
4. Public perception
The business structure your clients choose can also affect how they are viewed by clients, suppliers and project partners. For some stakeholders, see “LLC” or “Inc.” after a business name gives some assurance that the general contractor is carrying on a legitimate business.
5. Growth aspirations
What if your clients need outside financing to develop or expand their construction businesses? Obtaining loans and approving other financing can be easier for general contractors who operate as an LLC or corporation. Some lenders may not feel comfortable investing in sole proprietorships and partnerships.
6. Succession plans
Customers should also think about what they want to happen to their general business if they die, retire, or otherwise leave the business. With a sole proprietorship, the business dies when the owner dies, retires, or ceases to operate the business. This can also be the case with a general partnership – unless the partnership agreement provides otherwise.
Conversely, LLCs and C corporations allow businesses to continue beyond their owners.
In an LLC, ownership of the business is usually transferred pursuant to a buy-sell provision in the LLC’s operating agreement. For example, a member’s stake can be transferred to a new member, distributed among existing members, or reinvested in the business. Or the provision could require that the LLC be sold. In a C corporation, ownership can be changed by transferring shares from one shareholder to another.
What every customer should understand
No client will face the same opportunities and challenges when building and maintaining their business. For this reason, it is imperative for them, you, and their legal advisers to consider their particular circumstances when discussing the pros and cons of types of business entities. Choosing the one that best suits your immediate and long-term goals requires a lot of thought and homework. However, these efforts are worth it, as they can save time and potentially a lot of money in the long run.