Without subcontractors, the construction industry wouldn’t exist. General contractors rely on subs’ specialized licenses, expertise, and ability to deliver their portion of a project on time. And, for their efforts, subcontractors need to get paid. Hiring and paying your subcontractors shouldn’t be hard, we’ve got your answers in this guide.
What is a subcontractor?
On a construction project, a subcontractor is any party on a project who does not have a contract directly with the property owner. Instead, a general or prime contractor hires subcontractors – also called “subs” – and each sub signs a separate contract with the GC. A subcontractor can also contract with another subcontractor, which would make them a sub-subcontractor.
Learn more about the construction payment chain
A subcontractor typically specializes in a particular trade, like plumbing or electrical work. There is an almost endless list of the types of subcontractors.
Hiring a Subcontractor
Most industries hire independent contractors in some form or another, benefiting from simplified relationships, control over hours when work isn’t available, and limited liability. But few industries rely on subcontractors quite the way construction does. Despite the industry’s familiarity with subs, there are still a few things worth noting before hiring a subcontractor.
Contractor or employee?
The GC-subcontractor relationship is pretty straightforward in construction, but other industries aren’t so cut and dry. Occasionally, a company will hire a person for a job, and although they consider them a subcontractor, regulations might classify that person as having employee status.
Other than their right to payment, hiring companies have very little responsibility to an actual independent contractor. On the other hand, employees are entitled to overtime pay, minimum wages, and more labor rights. It’s easy to see why some companies in other industries would try to skirt the system.
Classification
Given the murky waters surrounding hiring independent contractors, the IRS, Department of Labor, and local state labor agencies all have tests to classify an independent contractor. In fact, California and some other states rely on the “ABC Test,” in which a person must meet all three requirements to be considered an independent contractor.
While this is typically less of an issue in construction, it’s worth familiarizing yourself with the federal laws and regulations in your state.
Credentials
Thus far, the difference between the way the construction industry and other industries handle subcontractors has been clear. However, some aspects of hiring subcontractors are universal, such as doing your homework beforehand.
General contractors need to check their prospective subcontractors’ credentials. GCs should be asking for references (and actually calling them). They should be asking for the appropriate paperwork like licenses, insurances, and other supporting documents. Also, if a GC can get a look at a would-be subcontractor’s profile, as well as their safety and financial records (among some other criteria), they’ll be getting a good look under the hood.
Paying a subcontractor
Setting up payments and actually paying a subcontractor for their services is straightforward. There are just a few things to square away.
Know your W9s & 1099s
When a general contractor begins a relationship with a subcontractor, they should obtain a W9. The W9 contains all of the tax information applicable for the subcontractor. The GC doesn’t need to send this form to anyone, but they should keep it for their records, and for filling out a 1099.
Regardless of the industry, business-to-business transactions valued over $600 require the hiring entity to send a 1099 to the IRS and the subcontractor/independent contractor. The general contractor will use the information on the W9 to fill this form out correctly.
Also, should there be a dispute as to whether the subcontractor could be classified as an employee, the W9 will strengthen the contractor’s case.
So even though the W9 never needs to leave the contractor’s office, it’s still important to obtain this document. Depending on the payroll program that a contractor uses, many offer simple portals for subcontractors to complete their W9s online. Regardless, ensure that subcontractors know that they need to fill out this compliance document to receive payment for their work.
“The act of working under a contract is what differentiates a sub or independent contractor from an employee.”
Create a contract
Never underestimate the importance of the construction contract. When you enter into a business relationship with a subcontractor, the contract needs to be clear and concise for a number of reasons.
For one, no one likes a hazy contract, and loose terms rarely benefit anyone. A clear scope of work accompanied with a predetermined payment schedule and resolution clause will help keep everyone on the same page.
Second, the act of working under a contract is what differentiates a sub or independent contractor from an employee. It also explains what’s expected of the subcontractor, which should prevent them from working outside of the duties you hired them for. Again, if there are any questions as to whether this person is an independent contractor or employee, the contract can help clear things up.
Establish payment terms
Outside of the scope of work, one of the most critical aspects of paying a subcontractor successfully is setting up payments. These payment terms determine how much is due and when, and there are many ways to structure them. Some common forms include:
- For small projects, the contract can include language that states half of the contracted amount is due at the onset of the job, with the other half due at the end of the project.
- For medium-sized projects, splitting the payments up into a 20/30/30/20 percent payment schedule makes sense. In this format, 20 percent is due at the onset of the job, 30 percent when half the project is complete, the other 30 when 80 percent is complete, and the remaining 20 percent when the job wraps up.
- For larger projects, much smaller percentages are typically due, but they’ll typically come at more frequent intervals.
- On commercial jobs, progress payments are even more typical, with payments coming at certain milestones in the lifespan of the project.
Regardless of how the contract outlines the payment terms, subcontractors should submit payment applications and invoices in order to get paid. The amount of time a contractor has to pay a subcontractor at that point varies based on the type of project (private, public, federal, etc.), pay-when-paid or pay-if-paid clauses, and more. However, the general rule in the ideal world is 7 to 14 days (though, again, that varies).
Send payment
There are many ways that a contractor can pay a subcontractor after receiving a pay app. They can pay cash (which is typically ill-advised without a proper paper trail), write a check, use credit, or direct deposit.
Also, some construction financial software enables contractors to make and receive payments electronically. The subcontractor can upload an invoice to the contractor’s payment portal for review. Once approved, the contractor can transfer the payment nearly instantly.
Liability & penalties for missed subcontractor payments
While they need the money to keep the lights on and grow their business, making sure your subcontractors are getting paid is critical to your business as well. There are consequences if you don’t, and they can make a real impact on your business.
First, understand that even if you aren’t getting paid, it’s your duty to make sure your subs are. A few years ago, a California bill passed that states GCs are actually liable for their subs’ employees’ wages, fringe benefits, and other benefits and contributions at any tier.
Some states have prompt payment laws as well. These laws determine how much time a contractor has to pay its subcontractors before they’re in violation of legal statutes. These violations can mean added interest and fees on payments your subs should’ve already received.
One other factor worth considering is the mechanics lien. On projects where subcontractors aren’t getting paid, they have the right to file a mechanics lien (as long as they’re protecting their rights according to the state’s laws). As mechanics liens attach to the property, they can mean big trouble for your business. The property owner might have a harder time securing financing, the property will be much more difficult to sell, and your reputation for bringing on liens will build.
For these reasons alone, it’s important to know who’s working on your projects to ensure they’re all getting paid.
Don’t overcomplicate paying your subcontractors
General contractors value their relationships with good subcontractors, so it’s important that they don’t overthink or overcomplicate the payment process. Once the background checks are done, getting the required paperwork and terms straightened out is all it takes. Getting those pieces of the puzzle out of the way helps a general contractor with paying a subcontractor on time, which in turn avoids payment disputes, delays, and liens—three things everyone on a project wants to avoid.