Contractors are the trade where the entity decision has the sharpest operational consequence, because in licence states the licence is issued to a legal person and that legal person is your company. A sole proprietor who holds a licence and later forms an LLC has not reorganised; in the eyes of the licensing board they have created a new applicant. That means a new application, a new bond, a requalification, and a period during which the new entity may not lawfully contract for work.
What follows uses California as the worked example, because the Contractors State License Board publishes its requirements precisely, and then covers the parts that apply everywhere: mechanics lien timing, workers compensation, and how subcontractor payments are reported. The general formation mechanics sit in the formation guide.
The Licence Belongs to the Entity, Not to You
Boards issue a contractor licence to an applicant, and the applicant is a named legal person: an individual, a partnership, a corporation or a limited liability company. Nothing about that licence transfers when the business changes form. The practical rule is that the entity decision has to come first, before the licence application, or it becomes a project of its own later.
California prices the difference plainly. Every active licence requires a contractor's bond of $25,000, set by Business and Professions Code section 7071.6 and effective from 1 January 2023 under Senate Bill 607. Where the licence is qualified by a responsible managing employee rather than an owner, a bond of qualifying individual of $25,000 is also required under section 7071.9. A disciplinary bond, required where a licence has been revoked, starts at $25,000 and can run to ten times the contractor's bond, up to $250,000, under section 7071.8.
Choosing an LLC in California adds two requirements no other form carries. Section 7071.6.5 requires a $100,000 surety bond for the benefit of the LLC's workers, on top of the $25,000 contractor bond, for both active and inactive licences. Section 7071.19 requires liability insurance with a cumulative limit of at least $1,000,000 for a licensee with five or fewer members, rising by $100,000 for each additional member up to a $5,000,000 cap. And section 7076.2 provides that if the LLC's registration with the Secretary of State is suspended, each person within the LLC may be held personally liable up to $1,000,000, which is a direct penalty for letting an annual filing lapse. The sole proprietorship comparison is worth reading against those numbers before assuming the LLC is automatically the right answer for a small trade.
Mechanics Lien Rights Run on Their Own Calendar
A mechanics lien is the strongest collection tool a construction business has, and it is forfeited by missing a date rather than by losing an argument. California's sequence is representative. Subcontractors and suppliers who may want to lien must serve a preliminary notice before work begins or within 20 days after, and the Contractors State License Board is explicit that a subcontractor or supplier who does not provide the notice loses the right to file a lien at all. Laborers and the prime contractor are exempt from serving it.
Recording deadlines then depend on whether a notice of completion is filed. Without one, contractors, subcontractors, laborers and suppliers have 90 days from completion to record a lien claim. With one, the prime contractor's window drops from 90 days to 60, and a subcontractor's or supplier's window drops from 90 days to 30. An owner can file that notice of completion within 15 days of completion, which means a subcontractor can lose two thirds of its lien window because of a filing it never sees.
Two habits protect the right. Serve the preliminary notice on every job as a matter of routine rather than on the jobs that look risky, since the risky ones are not identifiable in advance. And monitor the county recorder for notices of completion on active projects, because that filing starts a clock that nobody is obliged to tell you about. Both belong in the same operating rhythm as the invoice run, covered in the bookkeeping guide.
Form the entity that will hold the licence
We file the LLC with the state fee at cost and deliver the EIN, so the licence application, the bond and the insurance all name the same party.
Workers Compensation and Who Counts as Your Employee
Workers compensation is the exposure most likely to end a small contracting business, and the entity offers no protection from it. California requires every employer with one or more employees to carry cover. Operating without it draws a stop order that prohibits the use of employee labour until cover is obtained, and violating that stop order is a misdemeanour punishable by up to 60 days in county jail, a fine of up to $10,000, or both.
The financial penalties stack. The state assesses the greater of twice the premium the employer would have paid, or $1,500 per employee employed during the uninsured period. If an injury occurs while uninsured, the Workers Compensation Appeals Board may assess $10,000 per employee on the payroll at the time of injury for a compensable claim, or $2,000 per employee for a non-compensable claim, up to a maximum of $100,000. Operating uninsured is itself a misdemeanour carrying a fine of not less than $10,000 or up to a year in jail, plus state penalties of up to $100,000.
Classification is the adjacent trap. Treating a crew as subcontractors does not by itself make them subcontractors, and in most states an uninsured subcontractor's workers roll up onto the hiring contractor's policy at audit. Classification codes matter too: the rate difference between a roofing code and a carpentry code is large enough that misclassifying the work is effectively premium fraud. The classification guide covers the federal tests, and the payroll guide covers running employees properly once the answer is employment.
Paying Subcontractors, and What Has to Be Reported
Subcontractor payments are reported on Form 1099-NEC, and the threshold changed. For the current instructions the requirement is to file Form 1099-NEC for each person in the course of your business to whom you paid at least $2,000 during the year, replacing the long-standing $600 figure. The filing deadline is unchanged: section 6071(c) requires Form 1099-NEC on or before 31 January, whether filed on paper or electronically.
Two mechanics sit underneath that. Collect a Form W-9 from every subcontractor before the first payment, not at year end, and keep it on file for four years. Where a subcontractor does not provide a correct taxpayer identification number, or where the IRS notifies you that the number is wrong, backup withholding at 24 percent applies to reportable payments. A contractor who has paid a crew all year with no W-9 on file is choosing between a penalty and an awkward conversation in January. The 1099-NEC guide covers the filing itself and the W-9 guide covers collection.
On the entity's own tax, contracting is ordinary. Pass-through treatment applies by default and the S election becomes worth pricing once the owner's profit is comfortably above a defensible wage for the work being done, which for an owner who still swings a hammer is higher than most people assume. The reasonable salary guide and the switch guide cover both halves of that decision.
Standing Up a Licensed Trade Business, in Order
The licence application is the long pole. Everything that names an applicant has to exist before it goes in.
Contractors who work across a state line should treat that as two questions: whether the second state licenses the trade, and whether the entity must register there to transact business. The two have different tests and different agencies. The foreign qualification guide covers the second, and the licence lookup covers the first alongside the local permits.
The Penalties for Contracting Without a Licence
This is the sharpest set of numbers in any of these industries, and the most expensive item is not a fine at all. It is that the work becomes unpaid.
- $5,000 fine and up to six months in jail for a first misdemeanour offence
- $200 to $15,000 administrative fine, assessed separately from any criminal case
- 90 days mandatory jail on a second offence, plus 20 percent of the contract price or $5,000
- No right to be paid: the Board states that consumers are not legally required to pay an unlicensed person and cannot be sued for non-payment
- $1,500 per employee or twice the premium, whichever is greater, for operating without workers compensation
- $1,000,000 personal exposure for each person in an LLC whose Secretary of State registration is suspended
Compare that with the cost of doing it in order: a state filing fee, a $25,000 bond premium that is a fraction of the bond amount, and an application. The unpaid-work rule is the one that ends businesses, because it applies to work already performed and materials already bought. A contractor whose licence lapsed mid-project can find a completed $180,000 job legally uncollectable.
Three Contracting Businesses in Practice
Example 1: Cedar Line Builders
A licensed general builder operating as a sole proprietor forms an LLC on his accountant's advice, and assumes the licence follows. It does not. The LLC is a new applicant: a fresh application, the $25,000 contractor bond in the entity's name, the additional $100,000 LLC worker bond, and liability cover of at least $1,000,000. He signs two contracts in the gap between forming the entity and the licence issuing.
Outcome: The bonds were affordable. The two contracts signed in the gap were the problem, because payment on unlicensed work is not enforceable.
Example 2: Tallgrass Mechanical
A Texas HVAC company forms an LLC for $300. Texas does not license general contracting statewide, but it does license the mechanical trade, and municipalities license and permit separately. The company holds the trade licence, registers the entity, and finds that its permit obligations differ in each of the four cities it works in.
Outcome: No statewide general licence does not mean no licence. The local layer was the whole compliance burden.
Example 3: Brightwater Roofing
A roofing company pays a five-man crew as subcontractors on 1099s and carries no workers compensation. At audit the crew are found to be employees. The assessment is the greater of twice the unpaid premium or $1,500 per employee for the uninsured period, and one crew member had already made an injury claim, opening Appeals Board exposure of up to $10,000 per employee on the payroll.
Outcome: The 1099 paperwork was correct and irrelevant. The label on the payment does not decide the classification.
Five Mistakes Contractors Make at Formation
Mistake 1: Forming the entity after getting licensed
Why it hurtsThe licence belongs to the applicant. A new entity is a new applicant, with a new application, new bonds and a gap in which it cannot lawfully contract.
PreventionDecide the entity first, then apply once in that entity's name.
Mistake 2: Missing the LLC-specific bond and insurance
Why it hurtsCalifornia adds a $100,000 worker bond and at least $1,000,000 of liability cover for an LLC licensee, on top of the $25,000 contractor bond.
PreventionPrice the LLC-specific requirements before choosing the form, not after the application is rejected.
Mistake 3: Skipping the preliminary notice
Why it hurtsA subcontractor or supplier who does not serve the 20-day notice loses the right to file a mechanics lien at all, no matter how good the debt is.
PreventionServe it on every job automatically, and watch the recorder for notices of completion.
Mistake 4: Calling a crew subcontractors
Why it hurtsPaying on a 1099 does not decide status. An uninsured crew found to be employees draws twice the premium or $1,500 per employee, plus claim exposure.
PreventionTest the relationship against the classification rules, and require certificates from genuine subcontractors.
Mistake 5: Letting the state registration lapse
Why it hurtsIn California a suspended Secretary of State registration exposes each person within the LLC to personal liability of up to $1,000,000 under section 7076.2.
PreventionDiary the annual report and keep the registered agent current at all times.
Contractors doing repeat work for one developer should also read the classification question from their own side, since a single-client trade can look like employment to a regulator; the consulting guide covers that test. Contractors who fabricate their own components pick up product and workplace obligations covered in the manufacturing guide, and those working for landlords will find the owner's perspective in the property investor guide.
Decide the entity once, before the licence application.
In a licence state the entity is not an administrative wrapper around your trade; it is the applicant. Form it first, bond and insure it at the level the licensing statute sets, serve preliminary notices on every job, carry workers compensation from the first employee, and collect a W-9 before the first subcontractor payment. Everything expensive in this trade comes from doing those in the wrong order.
Contractor licensing and entity questions
Does my contractor licence transfer to a new LLC?
No. The licence is issued to a named applicant, so a new entity is a new applicant. That means a fresh application, bonds issued in the entity's name, and a requalification, with a period in between during which the new entity cannot lawfully contract for work.
What bonds does California require from a contractor?
A $25,000 contractor's bond under Business and Professions Code section 7071.6, effective 1 January 2023. A $25,000 bond of qualifying individual applies under section 7071.9 where a responsible managing employee qualifies the licence, and a disciplinary bond starts at $25,000 and can reach $250,000.
Are the requirements different if the licensee is an LLC?
Yes, in California. Section 7071.6.5 requires an additional $100,000 surety bond for the LLC's workers, and section 7071.19 requires liability insurance with a cumulative limit of at least $1,000,000 for five or fewer members, rising by $100,000 per additional member up to $5,000,000.
What happens if I contract without a licence?
In California a first offence is a misdemeanour carrying up to six months in jail and a $5,000 fine, with an administrative fine of $200 to $15,000 assessed separately. A second offence carries a mandatory 90-day jail term plus 20 percent of the contract price or $5,000. Consumers are not legally required to pay an unlicensed person.
When do I have to serve a preliminary notice?
In California, before work begins or within 20 days after. Subcontractors and suppliers who do not serve it lose the right to file a mechanics lien entirely. Laborers and the prime contractor are exempt from serving the notice.
How long do I have to record a mechanics lien?
Ninety days from completion where no notice of completion is filed. If the owner files one, the prime contractor's window falls to 60 days and a subcontractor's or supplier's window falls to 30 days, and the owner may file that notice within 15 days of completion.
What is the 1099-NEC threshold for subcontractors now?
The current instructions require Form 1099-NEC for each person to whom you paid at least $2,000 in the course of your business during the year, replacing the older $600 figure. The form is due on or before 31 January, and backup withholding at 24 percent applies where a correct taxpayer identification number is missing.
Form the entity that will hold the licence.
Entity formation with the state fee at cost, the EIN, and monitoring for the state registration your licence depends on staying active.
Written from the regulator sources below, each read on 13 August 2026. Bond amounts and penalties are set by statute and change; confirm with your licensing board before you apply.
- California Contractors State License Board, bond requirements
- California CSLB, licences for limited liability companies
- California CSLB, consequences of contracting without a licence
- California CSLB, mechanics lien timing
- California Department of Industrial Relations, workers compensation
- IRS, Instructions for Forms 1099-MISC and 1099-NEC
Disclosure. File.Business is a private filing service, not a government agency and not a law firm. We prepare and submit filings at your direction, and nothing on this page is legal or tax advice. Filing fees, deadlines, and statutory references are current as of the last-updated date shown above and can change. Confirm current requirements with the relevant state or federal agency before you file.
