Similar to documentation required for hiring an employee, companies must acquire certain documentation from their subcontractors. Without this subcontractor documentation, most likely the hiring business entity will face stiff penalties and expose their company to unnecessary risk. There are two major groups of documents needed, one is necessary in order to be in compliance with governmental agencies and the other is used to create harmony between the two parties involved.
The following is a list of compliance documents needed in order to comply with various government and legal authorities. In addition, I include a short write-up as to the requirements and the potential costs or risks for failure to maintain the respective forms.
- W-9 Request for Taxpayer Identification Number and Certification – A standard form that the subcontractor fills out and signs certifying that the Federal Identification Number used belongs to the subcontractor’s legal entity that interacts with the Internal Revenue Service. This particular form is used as a defense if notification is rendered by the IRS related to unpaid or underpaid taxes by the subcontractor. Failure to have the form on hand shifts the liability to the primary payer to withhold taxes at a rate of no less than 28% of all monies paid.
- CP575 Notice (issued by IRS, only a copy is necessary) – A standard letter sent by the IRS to the recipient (in this case the subcontractor) confirming the Federal Identification Number. You only need a copy of this letter, not the original. This is a good document to have, it is not mandatory, but highly encouraged for several reasons. First, it is a legal notice from the IRS confirming the identification number of the business and it should match the W-9 signed by the subcontractor. It acts as a vouching tool. Secondly, the most common reason to receive a confirmation notice from the IRS relates to the use of an improper identification number on Form 1099 issued to the subcontractor; often the identification number does not match the name or the address on the Form 1099. Thus the IRS is shifting responsibility to your administration staff to verify the subcontractor’s information and resolve the discrepancy.
- State Identification Documentation – Many of the states require any entity hiring subcontractors to verify the state’s identification number or have on hand a copy of the respective notice. This is similar to the same documents used at the federal level. For example, Massachusetts uses Form 5372. You simply need a copy of the form for your files. Research your respective state’s requirements commonly found on your state’s Department of Revenue website.
- Workers’ Compensation Insurance Binder – Every subcontractor should provide an insurance binder to their respective contractor. Typically, the subcontractor requests their underwriter to add the contractor on as an ‘Additional Insured’ and it shows up in the lower left hand corner with the contractor’s name. Without this certificate in your files, your worker’s compensation insurance audit will detect this and you will be held liable for the cost of the insurance. A common statement from subcontractors to their employer is that they are not required by law to provide this insurance when they employ less than two employees, i.e. they are a very small subcontractor. This is true in many states, but this law assumes that the business entity is NOT a subcontractor to another. Furthermore, this is irrelevant to your insurance underwriter, either you have insurance or you don’t; if not, then the hiring entity is liable for the insurance coverage. In effect, every person working on the job must be covered by insurance.
Once the compliance elements are satisfied, the two parties must now negotiate a mutually beneficial business relationship. This is really the more difficult part. It should start out with a sit-down and gathering of some other documents. Here is the list:
- Letter of Understanding – A simple one page mutual agreement to pricing and terms along with conditions. Most contractors use a formal letter that states the subcontractor is paid piece rate or by the project a certain set sum. It will further state that the subcontractor will sign a vendor agreement (explained below), agree to certain policies of the company, and will comply with a certain agreed upon time frame to complete the work.
- Vendor Agreement – A formal arrangement that identifies the legal parties involved; that the subcontractor is and independent party as defined by the respective state; how payments are processed; definition of completion; and industry/job issues that may be encountered and their corresponding resolution. This is a signature required document.
- Local Business License – In some states, local licenses are not issued, but proof of payment of the franchise tax is a substitute.
- Other issues requiring discussion (if applicable):
- Sales tax requirements,
- Proper documentation process for job site issues,
- Introduction to the management team and their corresponding responsibilities.
The end goal for both parties is to eliminate or reduce misunderstandings. Communication is key to success and communication is founded in the initial discourse. It is primarily the business entity that needs the service to ensure all compliance and relationship documents are completed. ACT ON KNOWLEDGE.
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