I have a new S Corp client who was issued a 1099-NEC in her name for services provided through the corporation. I advised her that this isn't compliant with S Corp rules, but her previous CPA told her it was acceptable as long as payroll taxes were paid on her Schedule C.

In the past, she has not run payroll through the S Corp, and no W-2s have been issued—just 1099s, and she reported the income on a Schedule C and has paid quarterly estimated taxes. I'd like to correct this and get her compliant by running reasonable compensation via payroll (possibly backdated), but I want to fully understand the risks.

What are the potential penalties or implications of not running payroll through the S Corp and instead reporting compensation on Schedule C? Has anyone dealt with a similar situation?