S Corp Owner Issued a 1099-NEC

[cmcclellan]

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?

[IRonMaN]

Since the 1099 route isn’t kosher, the IRS could come in and hit them with penalties and interest for late payment of payroll tax deposits and late filing of payroll tax returns.

[cmcclellan]

Thank you! So I assume the proper route to go then would be to backdate payroll and file payroll taxes (of which there will most likely be penalties at this point), issue a W2 for 2024, and then set her up on payroll for 2025?

[IRonMaN]

That would be the correct route.  A compromise would be to let slide for 2024 as long as the client was willing to convert to the correct route for 2025.

[qbteachmt]

Was the work she did of the nature that the S Corp is formed for, or does she have a "side gig" as well as the S Corp? Let's review that a 1099-NEC is informational, and for an S Corp, it isn't required. That doesn't make it an error. But if that has her SSN and not the EIN, that makes it an error if these customers hired the S Corp, and she did the work.

"and no W-2s have been issued—just 1099s"

From whom?

That's the mix up: Who the customers hired and paid vs who did the work. The more common mistake is someone uses the S Corp for the customer relationship, then doesn't go through payroll for the person doing the work, and then the S Corp pays and issues the 1099-NEC to the person doing the work, trying to bypass the corporation having to do payroll.

"What are the potential penalties or implications of not running payroll through the S Corp and instead reporting compensation on Schedule C?"

Why did an S Corp get formed? Is she really using the S Corp, or is it a shell and never followed through? It's not just payroll. The contracts for services should be in the name of the corporation; she signs business paperwork as President in the name of the corporation. She is supposed to get insurance, worker comp, and execute other business agreements in the name of the corporation.

Did she ever/never do any of this? Did she ever/never issue W9 to clients in the name of the S Corp, so they knew they are not hiring her, personally? Did the S Corp ever file as an employer for the Feds and State? Was there an 1120S? Or was everything always on the Schedule C? Or, was it just her "income" on a Schedule C?

Perhaps there is no error.

[IRonMaN]

" Let's review that a 1099-NEC is informational, and for an S Corp, it isn't required."

I read the post to mean that her corporation issued the 1099-NEC to her.  I think perhaps there is an error.

[cmcclellan]

Your understanding is correct — she is the 100% shareholder of the S Corp, and the work she performed was directly related to the business purpose of the corporation. Her previous accountant, who recently retired and had been handling the books, issued a 1099-NEC from the S Corp to her.

[BobKamman]

It is never the proper route to backdate payroll (whatever that means).  If you are suggesting that late payroll returns be filed, with payment of penalties that then with some work might be abated when neither you nor IRS has time to deal with them, what is the tax consequence of not doing so?  The SE tax she is paying equals (more or less) the FICA tax she would owe.  If she is paying her 1040 income tax quarterly, the FIT withholding that might have been owed on the 941s is collected anyway.

2024 is water under the bridge.  No harm, no foul.  Get her into compliance for 2025.  And as for what the previous CPA said:  That might be what was suggested, and she didn't want to do it, is why she came to you.  

My first reading of your post led me to think that the corporation's customer was issuing a 1099 to her personally for work done by the corporation.  Now, I wonder if you mean the only 1099 being issued is the one that her corporation issues to her.  In either case, it hasn't seemed to bother IRS yet.  And if it does, you may still have 2023 to deal with.