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Contractor's Plain-English Legal Guide
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Contractor's Plain-English Legal Guide

By: Quenda Behler Story

What Do You Need to Start a Construction Business?

The construction industry is filled with small builders, remodelers, and subcontractors — businesses that can’t easily afford $100 to $200 an hour to hire a lawyer to help them start up or to handle their day-to-day legal problems. But in modern America, legal problems are like snakes in the swamp — you might not see them, but you know they’re there.

This book is intended to help you get through the swamp without having to hire a $100-an-hour guide. It’s written to help small builders, subcontractors, and remodelers recognize and manage the legal tasks, which, with a reasonable amount of time and thought, they can do for themselves. Some of those legal tasks aren’t as difficult as you might think. In many cases, they are tasks a lawyer would simply hand off to his secretary. However, it won’t be the secretary’s hourly rate you’ll be paying. If you can read and understand the material for a contractor’s licensing test, you can certainly read and understand this book — and you can probably do all the tasks the lawyer’s secretary can do.

Another, equally-important purpose of this book is as a “heads-up” for those situations where you do need a lawyer — or some other kind of professional, like an accountant, an insurance specialist, or a financial advisor. When you need a professional, you need to get one before it’s too late. It’s a lot easier to pull someone out of a swamp when he’s only ankle-deep. When he’s in up to his neck, it’s a major job, if not impossible. Wait too long and sometimes all that a professional can do for you is collect a big fee.

Although, by using the Contents and the Index, you can find answers to your questions in this book without reading the entire book, I hope you do read it all. The book will give you a lot of general information that should help you stay out of lawyers’ offices as much as possible — not just by telling you what you can do yourself, but by telling you where the snakes in the swamp are hiding. Forewarned is forearmed. If it’s some-thing that can happen to you, it’s probably already happened to someone else. If you know how it happened to them, you can make sure you don’t go there. Why learn the expensive way?

And when a particular problem comes up in the course of your business, before you call your lawyer, check first to see if it’s covered in this book. I’ve tried to cover most areas of trouble. There’s a good chance I’ve covered that one. If so, maybe I’ve saved you a lawyer’s bill!

And now on to the subject of this chapter.

You want to start up your own construction business. You want to be the one who calls the shots and who makes the money. But even though you might not choose it, you’re in a partnership. Your partner is the government. It doesn’t pound nails for you, it doesn’t sell jobs for you, it doesn’t do any of the worrying or suffer headaches for you — but if you ever make any money, the government will be right there to share with you. Sometimes you can get a government agency to help you out, and we’ll cover that later in the book. But at startup time, you have to consider and follow their rules.

There are many requirements for a startup contracting business, and they come from several different levels of government. In this chapter we’ll cover the most important ones, whether you’re starting out alone at your kitchen table or setting up a corporation.

 

Can You Work Out of Your Home?

There’s one major advantage small construction companies have over the larger companies: It’s easier for a smaller company to keep its over-head costs low by not doing things like renting office space and hiring a lot of office staff. Many small construction businesses start out in a work-shop behind the garage, in the garage itself, in an extra bedroom, or off the kitchen table.

By using modern technology, a small construction company can do without all kinds of office help like receptionists, accounting clerks, and even salespeople and secretaries. Instead, you can use a telephone answering machine with voice mail, a pager, and a computer with spread-sheets and word processing programs.

Possible Zoning Problems

One possible problem with working out of your home is your local zoning code. Some communities restrict what kind of business (or how large a business) can be operated in a home or in a residential area. Remember that the zoning definition of “home” includes the barn and the garage and any other kind of outbuilding.

It’s how the property is zoned, not whether or not anybody is actually living in it, that makes the difference. You could have a vacant lot, but if that lot is zoned as residential, it’s intended to be used as somebody’s home. So whether you could put a trailer or a tool crib on that lot and use it as your permanent office would depend on what the local zoning laws say about what can be done in a home besides living in it.

Most zoning codes do allow some in-home businesses, but restrict the kind of business. The goal of these restrictions is to avoid the kind of traffic coming into residential neighborhoods that businesses, such as retail services or a business with several employees, would generate. The zoning laws especially want to keep businesses out of residential neighborhoods that use heavy, noisy equipment — such as construction businesses — that would disturb people in their homes.

The zoning laws also often restrict the kind of advertising a home business can do to indicate its presence. The idea is that commercial advertising in a residential area lowers property values. That’s why zoning laws typically either limit the size of a business sign or don’t allow one at all.

So before you set up shop in your home, you should check with your local municipality to see if it’s lawful to run your kind of business there. You should also plan on being discreet. Many communities don’t enforce their rules until the neighbors complain. If all you’re doing in your business-in-your-home office is making and receiving phone calls and sending and receiving mail, chances are there won’t be complaints. But if you have lumber delivery trucks rolling in and a steady flow of clients parking on the street, chances are you’ll be hearing from city hall.

What About Deducting the Home Office?

Until 1999, the IRS had a nasty little surprise for contractors who worked out of their home. The IRS said that if the office located in your home wasn’t your principal place of business, you couldn’t deduct it as a home office. What, you ask, is your principal place of business if you’re in the construction industry? The job site, the IRS answered.

One of the things that made this principal place of business rule so illogical was that if you went out and rented an office, you could deduct it even though you were doing most of your business at job sites, not at your office.

Under pressure from small businesses, the IRS changed its rule, and, starting in 1999, the principal place of business rule was changed to allow a home office deduction if the business’s principal administrative and management tasks took place there.

Even under the new rules, you need a place dedicated to the business before you can deduct a home office. That has to be absolutely the only thing you do there. If you work off your kitchen table, that table will never qualify for a deduction. Also, you can’t use your home office to create a business loss. In other words, you can only write off home office expenses against profits.

If you’re a sole proprietor and you want to write off a home office, you must fill out and file a Form 8829 along with your Schedule C. It’s a complicated form. If you use it, first ask for IRS Publication 586: Business Use of Your Home.

 

What Do You Need From the IRS?

There are as many horror stories about dealing with the IRS as there are about going to the dentist. I think that’s a shame, for two reasons. First, those stories can scare people out of doing some really easy things that they need to do, because they think they will be too complicated to handle on their own. Second, when people get into trouble, they think they’re doomed. They often become paralyzed with fear and don’t deal with the situation. Now, sure, I know some people have had some genuinely night-marish experiences with the IRS, but I think those are statistically rare. I also think that, in some of these horror stories, the person telling the story doesn’t always include every single fact. Sometimes the situation wasn’t quite as one-sided as their story suggests.

My experience with the IRS (knock on wood) is that mostly the agents want to help you work out your problem.

There’s a very useful publication, available free from the IRS, that you should get right away. It’s Publication 334: Tax Guide for Small Businesses. It’s available at IRS offices, or they’ll mail one to you if you ask for it. You can also phone them at 1-800-829-3676 to ask for the publication.

What About a Taxpayer Identification Number?

The first thing you need from the IRS is a number, although you may already have it. You’ll have lots of forms to file with the IRS — and the IRS keeps track of those forms with numbers, not names, so it’s important to get the right number to put on your tax forms. You’ll need some kind of taxpayer identification number — what they call a TIN — to put on your forms so those forms don’t get lost. The phrase taxpayer identification number includes several different kinds of numbers. You may already have all the taxpayer identification you need: your social security number. Depending on your situation, you may not need anything else. Here’s how to tell if you can use your social security number, or if you need to apply for a TIN.

For a Sole Proprietorship

If you’re not a partnership or a corporation, and if you have no employees, you can simply write your social security number on those lines on your 1040 form, Schedule C and on your quarterly self-employment income reports that ask for your EIN (Employer Identification Number).

For a Partnership

Partnerships don’t have social security numbers, so your partnership will need the kind of taxpayer identification number called an EIN (Employer Identification Number). Your partnership TIN is an EIN. Got that? All joking aside, you’ll need an EIN for your partnership even if you don’t have any employees.

Without an EIN, all the income the partnership earned would be credited to whichever partner used his or her social security number on the partnership reporting forms. That partner could owe a lot of extra tax to the IRS, while the other partners get a free ride!

To get an EIN, fill out an IRS Form SS-4 and mail it to the IRS. The IRS will assign a number to the partnership and mail it back.

For a Corporation

Corporations must have an EIN even if they don’t have employees. Fill out the SS-4 form, send it to the IRS, and the IRS will assign an EIN number to your corporation and mail it to you. This number will be only for the corporation, not for the shareholders — even if there’s only one share-holder.

For Any Business That Has Employees

If your business has employees, it’ll need an EIN even if the business is a sole proprietorship. To be sure your reports and payments get credited at the right places, you’ll also need your employees’ social security numbers. You get those by asking your employees to fill out W-4 forms for you. The IRS will mail all of these forms to you if you just call and ask. Their phone number is 800-829-3676.

There’s more information on these topics in Chapters 5 and 6. Also, the IRS publishes a free publication, which is surprisingly clear and readable, called Circular E, Employer’s Tax Guide. When the IRS mails you your EIN, it sends along a copy of Circular E.

 

What Do You Need From the State?

The state regulates your business names, your license requirements and may impose some additional tax requirements. Your state may or may not have an income tax. It may charge sales tax on some of your installation activity. Contact your state treasury and find out what you have to do to satisfy your state tax requirements.

You Probably Need a License

Most states don’t allow anyone without a contractor’s license to do business in the construction trade. The penalty for doing business without a license is usually that any contractor who’s not properly licensed can’t sue to collect payment for completed work. So if you’re unlicensed and your customer stiffs you, there’s not much you can do about it. The customer may get the work for nothing. More about this later in the chapter.

The licensing requirement is meant to protect consumers. The idea is that by requiring a license, the state can set some minimum standards. That’s not a bad idea in an industry where anyone who owns a hammer thinks he’s a carpenter. By preventing an unlicensed contractor from collecting for his work, the state motivates contractors to get their licenses — and does it without spending a lot of money on investigators and enforcement.

There’s another way the licensing laws protect consumers. If the customers of a licensed contractor believe that the contractor has cheated them, they can make a complaint against that contractor’s license. If the state then determines that it’s a valid complaint, the state can fine the contractor, or even cancel that contractor’s license. Generally speaking, the state won’t usually pull a contractor’s license just for complaints about bad workmanship, unless the contractor’s work has actually caused a dangerous situation. In circumstances involving bad workmanship, the state usually just leaves the customer to his or her warranty rights.

But usually the state does act against the contractor’s license in cases where the contractor has accepted money, then either didn’t start the work, or didn’t finish it.

Taking away a license is an administrative procedure. A contractor whose license is threatened can, and probably should, seek the help of a lawyer.

A contractor’s license can also be revoked for failure to pay the mandatory annual licensing fee. That’s usually automatic.

How to Get a License

State licensing requirements vary widely. Not every state requires a license for every construction activity. Some states issue a one-size-fits-all sort of license, which lets the person with the license do everything. Other states break down their licenses into specialties such as general contractor, and specific trades, such as electrician, plumber, and so forth. The license may also act to regulate activities such as advertising, selling, and some aspects of the contracts between customers and contractors. Craftsman Book Company, the publisher of this book, has a Web site called Contractors-License.org that details the licensing requirements in each state. It has frequently-updated information on states’ requirements, and links to each state’s contractor’s license Web site, where you can find out if a contractor has a license and if it’s current, and learn other useful information.

Before issuing a license, most states require applicants to demonstrate that they have some experience in construction, and that they’re credit-worthy. Some states make the applicant pass a test. And some, my home state of Michigan, for example, require all three: experience, creditworthiness, and an examination.

Who Must Be Licensed?

In Michigan, anyone who is self-employed and works in the construction trade has to have an appropriate license. Michigan has different levels of construction licenses. A general contractor’s license is available for builders or remodelers. There’s a residential maintenance and alteration contractor’s license (you have to pass a trade test for your particular trade), and separate licenses for electrical, plumbing and mechanical con-tractors. Also, anyone selling remodeling or building projects has to be licensed as a salesperson and work under a builder or contractor who is also licensed.

But there are some exceptions to the requirement for licenses. In some states, a construction worker doesn’t need a license to perform work for less than $600 compensation. There are some other exceptions, too. Be sure to check in your state before you start working as a contractor.

Some states, Kansas for example, don’t license contractors at all. But cities or counties in those states might. So if you find you’re in a state that doesn’t require a license, don’t assume that you’re off the hook and can start building. You might be in for an unpleasant and expensive surprise!

Homeowners — A homeowner or a landlord doesn’t need a license to build anything on their own property (although they’ll probably need a building permit).

Developers — In a state that requires builders to be licensed, any land developer, subdivider, or real estate agent who owns the property and intends to sell it, must have a construction license or use a licensed contractor in order to build on the property. They don’t get the homeowner’s exemption because they don’t intend to make their home on the property — they’re holding that property for resale.

Subcontractors — Most states require that anyone doing business in the construction trade get a license. “Doing business” includes subcontracting for other contractors.

Partnerships — Different states have different rules about partnerships. Some states allow a partnership to use the license of one of the partners. However, the partner who has obtained the license must be a managing partner, or the partnership cannot legally use his or her license.

States such as Michigan require a partnership to have a license in the partnership’s name, even though one or more of the partners is already individually licensed. When the partnership applies for the license, one of the partners (it must be a managing partner), takes the test. The license is then issued in the name of the partnership and it becomes a partnership asset.

Joint ventures — A joint venture is a kind of partnership, so most states require a joint venture to do whatever partnerships are required to do. If the state requires a partnership to obtain its own license, a joint venture must also obtain its own contractor’s license. That’s true even if the joint venture has only been set up for a limited project such as building a single mall, one building, or an apartment building. The requirement applies even if the joint venture is set up by two or more partnerships that have their own licenses.

Corporations — Some states won’t license corporations. They only license individuals. So in those states, an individual in the corporation must get a license in the company name. The person who takes the tests and qualifies for the license on behalf of the corporation must hold a managing position in that corporation.

A few states won’t let construction companies incorporate at all. The states that do allow construction companies to incorporate generally require those corporations to get their own license, even though one or more of the individual shareholders in the corporation may already hold a license.

Are There Penalties for Not Having a License?

There are criminal penalties for engaging in the construction business without a license. It’s a misdemeanor that’s punishable by a fine or imprisonment — or both. However, the public prosecutor is the one who decides whether or not to enforce criminal penalties. Usually the public prosecutor isn’t interested in putting unlicensed contractors in prison, unless they’ve been cheating their customers.

The real penalty for contracting without a license is that a contractor without the proper license can’t sue a customer. That means he can’t sue for nonpayment or enforce a construction lien, because a contractor has to go to court to foreclose on a lien. For more information about construction liens, see Chapter 7.

The license requirement gives consumers a powerful way of protecting themselves from the dishonest or unskilled contractors (who tend to be the ones without a license). Consumers dealing with an unlicensed contractor may not have to pay for the work the unlicensed contractor did for them. They may even be able to get any money back that they’ve already paid to the unlicensed contractor. In some states, this is true even if the customer actually knew the contractor was unlicensed and lured him into doing the work, knowing that the contractor wouldn’t be able to collect.

This can be hard on contractors who weren’t acting in bad faith. There are cases where the contractor was unlicensed only because of a technicality or a failure to promptly pay a license renewal fee, but still wasn’t allowed to sue to collect payment. It sounds harsh, but the courts rigorously enforce the rule against letting an unlicensed contractor sue a customer. After all, it’s an effective way to enforce the state’s licensing laws. It gives the contractor a powerful motive to make the effort to get that license.

Exceptions to the rule — Some states will allow a contractor some recovery (on an unjust enrichment, or quantum meruit theory) if the contractor can demonstrate that the failure to have a license was only a technical error. For example, unlicensed contractors have been allowed to sue their customers for payment in the following cases based on these facts:

  • Two licensed contractors had set up a joint venture partnership. They were both properly licensed, but didn’t realize that their joint venture was supposed to have its own license.
  • Another contractor had a license for the bulk of the time that the work was being done, but had failed to renew it promptly. He was only unlicensed for a brief period of time.

However, no unlicensed contractor should count on this relief. There’s at least one case on record where the court refused to let a contractor collect from a customer where the contractor worked on the project for several months and was unlicensed for only ten days because he had failed to make his annual license payment.

This is an area in which the law varies from state to state. If you’re involved in this kind of problem, you should get help from a lawyer who knows exactly what your local laws are. Your lawyer may tell you that you’re in a state that closes the courthouse doors to an unlicensed con-tractor — period. You might as well not bother trying. Just write it off to the high cost of experience. However, you may be in one of those states where, in certain situations, unlicensed contractors can sue for unjust enrichment, or quantum meruit.

Impact on the property owner — The penalty for not having a license doesn’t have any impact on the property owner. The law is only intended as a hammer to force unlicensed contractors to get licenses. It’s not intended to punish anybody else. Even though the courts are closed to an unlicensed contractor, a property owner could sue his unlicensed contractor for breach of warranty and even for breach of contract.

Let’s look at an imaginary example: Harry Homeowner hired Contractor Cal to build a room addition. The contract price was $15,000. When Contractor Cal was two-thirds done (and Harry had paid him $10,000), Harry learned that Cal had no license. He immediately told Cal to stop work, and hired a licensed contractor to finish the job. This second contractor charged Harry $9,000 for the balance of the job — $4,000 more than he would have had to pay Cal.

Even though it was he who stopped Cal from finishing, Harry can now sue Cal for breach of contract. Cal could be made to reimburse Harry the $4,000 difference. In a few states, Harry could even get back the $10,000 he’s already paid Cal as well.

A homeowner could also sue an unlicensed contractor who has violated his warranties of good workmanship or fitness of purpose. For example, suppose an unlicensed contractor installed a deck without proper footings and in the first winter, the deck heaved and racked out of square. The homeowner could sue the unlicensed contractor for breach of warranty. The one thing that a property owner can’t do, however, is sue for specific performance. A lawsuit for specific performance is one that demands that the court order the defendant to complete his contract. A contract with an unlicensed contractor, in a state that requires a license, isn’t enforceable. It would be an illegal contract, and the court won’t order anyone to perform an illegal contract.

Suppliers to an unlicensed contractor — A supplier to an unlicensed contractor doesn’t lose the right to sue the unlicensed contractor. But in most states, a supplier to an unlicensed contractor does lose his right to a construction lien on the building site. Since the unlicensed contractor couldn’t enforce a lien against the property owner, the supplier can’t either.

In order to get compensated for materials already supplied to a job, most states will allow the supplier to sue the homeowner directly for unjust enrichment. After all, Bigger Lumbers didn’t intend to donate the materials to Harry the homeowner, and Harry surely expected to pay somebody at some time for materials. Unfortunately, the damages on an unjust enrichment lawsuit can present a further problem for Bigger Lumbers. What you win in an unjust enrichment lawsuit is supposed to reflect the value of the goods, which may not be the same as the cost of the goods.

And, in most states, Bigger Lumbers won’t be able to get paid if Harry has already paid Cal, the unlicensed contractor, for the materials. They won’t make Harry pay twice for the construction materials used on his job. In many states, this is true even when Cal does have a license.

Subcontractors to an unlicensed contractor — Suppose the subcontractor has a license, but the contractor doesn’t. If the contractor doesn’t pay the subcontractor, the subcontractor can sue the unlicensed contractor for payment. In fact, the subcontractor could sue the contractor for payment even if the subcontractor didn’t have a license, either. It’s only the homeowner who can’t be sued. Licensed or not, the subcontractor can’t sue the homeowner if the general contractor didn’t have a license. The subcontractor doesn’t have any rights against the homeowner that the general contractor didn’t have. That’s because the subcontractor’s rights are derivative. That means the subcontractor gets (derives) his rights from the contract between the homeowner and the general contractor. If the general contractor can’t sue the property owner, neither can the subcontractor.

In Michigan, a licensed subcontractor who was working with an unlicensed contractor wasn’t even allowed to collect against the Builders Fund when the unlicensed contractor didn’t pay him. The court ruled that the contractor couldn’t have collected from the Builders Fund, so his subcontractor couldn’t collect either. That’s in spite of the fact the fund was established to protect (among other people) subcontractors from property owners who don’t pay.

Another contractor — The legislation barring unlicensed contractors from suing property owners for collection is only intended to protect the property owner. It has no effect on another contractor doing business with the unlicensed contractor. Other contractors or suppliers can sue the unlicensed contractor, or the unlicensed contractor can sue them. In fact, they can sue each other even if none of them is properly licensed.

For example, suppose an unlicensed contractor hired a properly-licensed subcontractor to pour a foundation, and a big crack opened up because the cement was improperly cured. The unlicensed contractor can sue the subcontractor for the money it cost to repair the crack and for any money that the delay cost the contractor.

What About Design and Build Contracts?

Some states require design professionals to be licensed by the state. In those states, a construction contract that includes design functions that aren’t performed by a licensed engineer or architect may not be enforceable by the contractor against the homeowner, because of the lack of a proper license. However, most states that require a separate design license have held that a contractor without a design license is permitted to do design work under the supervision of a licensed design professional, like an architect or engineer.

What About Federal Projects?

Federal law, not state law, applies to federal projects. Federal agencies have their own rules and regulations about which contractors can do federal work. If a contractor or a subcontractor working on a federal project meets the federal requirements, it won’t matter if that contractor isn’t licensed by the state the project is in. And any contractor, licensed or not, can sue if he doesn’t get paid for work done on a federal project.

The Name of Your Business

Even if you’re running an unincorporated business all by yourself off your kitchen table, that business is still separate from you in some sense. Customers or suppliers may not realize that you are John’s Better Roofs, so most states require you to file the name of your business with some local agency.

Assumed Names

In most states, unincorporated businesses must register their business name in what’s usually called a fictitious or an assumed name registry. There’s nothing sinister about that — it just means you’re doing business under a name that’s not exactly your own. That business name must be registered even though it includes your name.

For example, John Smith can advertise himself as John Smith, Master Carpenter. Even though that business name includes his own actual name, it’s also the name of his business. Most states will require it to be registered as an assumed name.

The law in some states doesn’t use the terms “assumed name” or “fictitious name.” Instead, those states may describe you as a company “Doing Business As . . .” or even just as a “d.b.a.” The term is different, but the intent is the same.

In Michigan, you have to register with the Assumed Names Index, located in the county clerk’s office. Some states require a filing at the state level and publication in a legal newspaper along with the registration. That gives someone who’s already using that name an opportunity to object.

Selecting a Business Name

Before you chose a business name, try to make sure no one else is using that name, because it’s against the law to use a business name that already belongs to someone else. While it’s not actually a crime unless you do it with intent to deceive, if someone else is already using that name, they could sue you for trademark infringement. They could collect damages from you, and force you to stop using that name, even if you’ve built up a business under that name.

If there’s a business already registered under that name in the Assumed Names Index, the county won’t accept your registration. But you can’t assume that just because they do accept the registration, there’s no one in the next county or somewhere else in the state using that name. When you’re choosing a business name, take reasonable precautions, like first checking phone books and directories to see if someone else is already doing business under that name. Nowadays you’d better check on the Internet too!

If your name is John McDonald and you want to call your company McDonald’s Construction Company, will there be a problem with that? Probably not — for two reasons. First, because you’re using the word construction as part of the name. That means people hearing your company name won’t assume you’re selling hamburgers. If you were, or if you were a restaurant or some kind of food supply company, you’d be hearing from McDonald’s expensive attorneys. The second reason it’s probably all right to use McDonald’s Construction Company is that McDonald’s most likely hasn’t registered that name as a trademark in conjunction with construction. If they have, you’ll be hearing from their attack-attorneys.

Corporation Names

Corporations aren’t usually required to file assumed or fictitious names or d.b.a. certificates with the county agencies. The name of the corporation and its official address is already on record with the agency in the state that regulates corporations. But the corporation will have to register if it’s doing business under a name other than its corporate name. Like individuals, corporate names can’t infringe on someone else’s trademark.

In addition to trademark restraints, most states regulate what a corporation can call itself. That’s to protect people who may not realize that they’re doing business with a corporation, and therefore can’t sue the individual they’re doing business with for nonpayment or breach of contract. They can only sue the corporation.

State laws have strict rules about what can be put into a corporation name, and they’ll review the name of a corporation to see if it meets their standards before accepting the incorporation papers. What the state wants is something in the business name that makes it clear to people doing business with that company that it is a corporation. The name has to include words like Incorporated, Corporation, Company or Limited. Usually, an abbreviation like Inc. or Ltd. is also okay. Corporations do have to file an assumed names certificate if they’re using one. If the corporation chooses to do business under an assumed name, even that assumed name has to meet the state corporate naming standards.

 

What Records Should You Keep — and Why?

Personally, I don’t think you should ever throw away business records. You might not agree, especially if you can’t put your car in the garage because of all the banker boxes full of records you have stored in there. So, what I’m going to do here is talk about the minimum time you should keep your records for legal purposes. There are four legal reasons, besides business reasons, you should plan to keep your records.

You Might Need Your Records for Tax Audits

The IRS regulations say you should keep your receipts, canceled checks, and other financial records for whichever is longer: either three years from the due date for filing your return, or two years from the date the tax was paid. If you have employees, you must keep your employee withholding records for at least four years.

That’s what IRS regulations say, but believe me, the real number is six years. That’s because the IRS has six years to assess you if you failed to report gross income 25 percent greater than what’s shown on your income report. So, just in case you’re accused of that, you’d better keep the records to prove you didn’t — or at least, didn’t do it intentionally — for six years.

If you aren’t filing tax returns at all, then just keep everything forever. If you’re caught, at least you’ll have some evidence refuting the Rockefeller-like income that the IRS could decide you had.

Your Insurance Company Might Audit You

You should keep copies of your contracts with subcontractors and copies of their certificates of insurance on file for at least three years, because your workers’ compensation insurance company might audit your records. If they do audit you, and if they find that you don’t have copies on file of your subcontractors’ insurance certificates, the insurance company may assume that’s because your subcontractors weren’t insured. What’s your insurance company likely to do about that? They’ll hit you with a nasty surcharge, because you’ve exposed them to more liability than they’d agreed to accept. Insurance companies hate that.

You Might Be Sued

Another good reason to keep your records is because somebody might sue you. It could be a breach of contract lawsuit, a warranty lawsuit, or a problem with an employee (like a workers’ compensation claim for an injury you say never happened).

Your testimony in a lawsuit is more convincing if you have business records that support it. Even if these are records you prepared yourself, they’re admissible in court if you prepared them in the ordinary course of business. As long as you wrote it down at the time of the event (and you typically do write down that kind of event), written evidence is more convincing than anybody’s memory — and a darn sight more likely to be accurate.

For legal purposes, I recommend keeping copies of all your business contracts, purchase receipts, punch lists, employee injury records, and a daily phone log that includes all phone contacts with your business customers and the job site. Even if you don’t actually use these records in court, it’s important to have them to jog your memory. You’d be surprised how easy it is to forget the details of even the most difficult and contentious situation.

Statute of Limitations

You don’t have to live in fear of a lawsuit for the rest of your life. People can’t wait forever before they decide to sue. It’s simply not reasonable to let a potential lawsuit hang over someone’s head indefinitely. So, if someone has the right to sue you for some reason, the law requires that they do so within a reasonable period of time — before all the witnesses die and everyone has forgotten what the fuss was about in the first place.

The law that says the right to sue expires after a certain number of years is called the Statute of Limitations. Different states use different periods of time for their Statute of Limitations. If you’re in a situation where you need to be concerned about that, you should check with your attorney.

The Statute of Limitations varies for different kinds of lawsuits, and for different states. But for most kinds of civil (noncriminal) actions, the average limitation is three years. I suggest keeping your records for six years, however, because there are situations in which the plaintiff could get extra time to bring a lawsuit.

For example, if the plaintiff is a minor, the Statute of Limitations won’t even start expiring until the plaintiff becomes an adult. That means that if a child trespassing on your job site was injured, that child could possibly wait until he or she was 18 to sue you. In a situation like that, I’d advise getting some legal advice about what you might be able to do to keep this from hanging over your head for years. Your liability insurance carrier may also have some legal assistance to offer you in this situation.

Keep All Employee Records

When you’re deciding what records to save, don’t forget to keep all of your employee records for at least three years. You should keep their personnel files, including all applications, evaluations, injury reports, W-4s and INS I-9 forms, as well as any complaints about them. Workers’ compensation claims have very short notice requirements, but other kinds of claims, like discrimination or ADA issues, have different standards.

The IRS requires that all new employees fill out W-4 forms, which include their social security numbers and how many dependants they want to deduct. The employers don’t have to file these forms with the IRS in most situations, but they must keep their employees’ W-4s in their office files.

When you hire someone who’s not a citizen, you must fill out and keep an INS Form I-9, which you can get from the Immigration and Naturalization Service. In the I-9 form you swear that you believe that your employee isn’t an illegal alien, because you took reasonable steps to check his or her status. Those reasonable steps include checking immigration papers. You should make copies of the papers you examined and keep those copies with the I-9 form in your office files for at least three years after hiring or for at least one year after terminating that employee.

Summary

In this chapter we’ve covered most of the issues you’ll have to consider when you start your business. Remember, some of them depend on what kind of business you set up — sole proprietorship, partnership or corporation. But how do you decide which is best for your business? That’s the subject of the next chapter.

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