Everyone is concerned with potential exposure to liability, and this is especially true in the construction field. Contractors want to know how they can protect their home and other assets (bank accounts, rental properties, stocks, bonds, etc.) if they get sued by a disgruntled homeowner. There are many ways to shelter your personal assets from business-related liabilities, one of which is to incorporate your business. This means forming a corporation by filing some documents with the Secretary of State’s office and transferring your business to that corporation. Your business consists of the contracts for future work, the receivables, the trucks and tools, the business name, and so on.
While it is quite easy to form a corporation, it is not so easy to operate a corporation, especially if you have been in business as a sole proprietor for many years. When you are a sole proprietor, the money your business makes is your personal money and the debts your business incurs are your personal debts. There is really no distinction. When you form a corporation, that changes. The corporation makes the money and incurs the liabilities. Therefore, if the corporation signs a contract to remodel a kitchen and the homeowner is dissatisfied with the work, the homeowner must sue the corporation to get satisfaction, not you, the contractor. If the homeowner gets a large judgment and there are insufficient assets in the corporation to satisfy it, the homeowner cannot come after you for the balance. Thus, your personal assets are safe . . . or are they?
The problem arises when you don’t operate the corporation as a separate entity. In other words, you keep doing business the same old way. If you’re going out to dinner, you reach into the petty cash drawer and take out $100 to cover the meal; when you talk to a client, you tell them how “you” are going to remodel the house instead of how “your company” is going to remodel the house. If you treat the corporation as simply an extension of yourself, then the court can declare the corporation a sham and “pierce the corporate veil,” allowing the homeowner to reach your personal assets to satisfy their judgment. Here are some simple rules to follow to make sure that does not happen:
- Complete all your initial corporate documents, including bylaws, organizational meeting minutes and filings with the state. Your attorney can make sure these are done correctly.
- Have stock certificates issued to you as the owner of the company.
- Hold regular corporate meetings (at least annually) and keep minutes (notes) from the meetings in a corporate binder.
- Change your business documents to indicate that you are now a corporation. This usually means adding “Inc.” to the end of your business name. This is an expensive step because it means getting new business cards, signs, stationary, contracts and more.
- Open a separate bank account in the corporate name. And don’t pay your grocery bill out of the corporate bank account!
- Become an employee of the corporation and issue yourself a regular paycheck.
- Get a corporate tax identification number from the IRS.
- Get a separate contractor’s license issued in the name of the corporation.
- Prepare and timely file any annual forms required by your state.
- Change your vendor accounts to your corporate name so future invoices come to the corporation and not to you personally.
- Make sure all client checks are written to the corporation and not to you personally.
- If you operate your business out of your home, prepare a lease with you and your spouse as landlords and the corporation as the tenant. Have the corporation pay you rent every month for the use of your home.
You have worked too long and hard building up your personal wealth only to lose it because of silly mistakes.
Nancy A. Chillag is a construction attorney in Menlo Park, Calif., practicing for over 20 years. She is the author of Building by the Book: Legal Advice for Contractors.