By having your S corporation pay you on just a 1099, you have the following three issues:

  1. Your S corporation violates tax law because it fails to pay you W-2 wages for the services you performed for the corporation.
  2. The IRS can reassign your S corporation’s 1099 payments as wages and hand the S corporation a hefty tax bill consisting of back payroll taxes, interest, and penalties.
  3. You are likely to have deductible expenses with the wrong entity. Tax law requires that the expense deduction belong to the entity that incurred the expenses and earned the related income.

If you pay yourself on both a 1099 and a W-2, you also have tax issues:

  • You likely pay several thousand dollars more in self-employment tax than required.
  • You muddy the water when it comes to business deductions. It may be very unclear whether you should deduct the expenses on Schedule C or on the S corporation return. This confusion can cause you to claim the expenses on the wrong tax returns and can enable the IRS to deny your valuable business deductions.

This shows how you can do yourself a favor and also keep things simple. During this discussion, we’ll talk about avoiding trouble with the IRS by keeping the business deductions inside the S corporation and by paying yourself reasonable compensation as a W-2 wage.