In the world of small business, there are many ways in which business owners and those who work for them operate financially. Whether a regular paycheck or a periodic contract, each method has a specific way to be accounted for with the IRS. One type of business is an S-Corporation, and one type of tax form used is a 1099. Understanding what both of these mean is important to ensure each party—the payee and the payer—is being treated fairly and legally.
An S-Corporation is a type of corporation that passes income, losses, deductions and credit to shareholders. Small businesses, partnerships and LLCs often elect to operate as an S-Corporation for the purpose of avoiding paying tax twice, both as corporate profit and as individual income or dividends. A partner in an S-Corporation can receive profit distributions from the corporations but is also supposed to be paid a reasonable salary on at least a quarterly basis.
A 1099 is a kind of tax form that accounts for income outside a traditional salary or paycheck. They are issued to account for independent contracting work, interest or other types of nontraditional income. The most common types of 1099s are 1099-MISC (for independent contracting), 1099-DIV (for dividends), and 1099-INT (for interest). 1099s are usually issued to individuals, not to businesses such as an S-Corporation.
S-Corporation & 1099s
An S-Corporation may issue a 1099 for an independent contractor for services provided on a periodic or one-time basis. Although not common, an S-Corporation may also receive a 1099 for its own services. This is usually not the case but does occur in some instances for medical services or attorney's fees.
Do Not File
A common area of mistake or confusion is the practice of an S-Corporation issuing its own employees or shareholders 1099s. An S-Corporation may not issue a 1099 in place of a reasonable salary to an employee. For instance, if there is a single employee in an S-Corporation, they must be paid a reasonable salary (at least quarterly), the S-Corp must pay payroll taxes on those Social Security and Medicare benefits and file the appropriate forms (including but not limited to 941s and W-2s). Failure to pay an employee properly can put the S-Corporation at risk for an audit and possible penalties by the IRS.