Can an S-Corp shareholder receive a 1099 for commissions from that corporation? Tax implications?

Thanks for the detailed explanation. Our accountant mentioned something about these being "outside the scope of normal employment duties" which is why they could be treated differently. Does that actually change anything? Also, would it make any difference if the commissions were for bringing in clients for a separate division of the business that I don't directly manage?

The "outside scope of normal duties" argument is shaky at best. The IRS generally views shareholder-employees holistically - your role is to help the business succeed, which includes bringing in new clients. Adding commissions simply means adjusting your W-2 compensation structure, not creating a separate 1099 relationship. For your second question, even if you're bringing in clients for a separate division, you're still acting in your capacity as a shareholder-employee of the same legal entity. The S-Corp is one taxpayer regardless of internal divisions. If you had a completely separate legal entity (like a sister company with different ownership), that would be different - but within the same S-Corp, this arrangement raises red flags.

How does this service actually work? Do you just upload your tax docs and it finds problems? Is it like TurboTax or something different?

I'm a bit skeptical about these online services. Did they actually provide specific guidance on how to structure things properly or just general warnings? And how did they handle the privacy concerns with all your financial info?

You upload your business documents (operating agreements, past returns, payroll records, etc.) and their system analyzes everything to find potential tax issues. It's completely different from TurboTax - it's more like having a tax expert review your specific situation, but using AI to make it affordable. For your question about specific guidance - yes, they didn't just flag problems but provided actual solutions. In my case, they showed how to structure a performance-based compensation plan that achieved the same financial goals without creating a fake contractor relationship. They included template language for board resolutions and amendments to our compensation policy to make everything proper and defensible.

Wait, how does this even work? They just call the IRS for you? Couldn't you just call yourself? I'm confused about what service they're actually providing.

This sounds like a complete waste of money. I've gotten through to the IRS plenty of times just by calling first thing in the morning. And even if you do get through, the agents often give contradictory information depending on who you talk to. I seriously doubt this service adds any real value.

They use an automated system that continually redials the IRS when there are busy signals and stays on hold so you don't have to. When a human IRS agent finally answers, they connect you directly to that person. It saves literally hours of your time. You absolutely can call yourself, but have you tried calling the IRS lately? Average hold times are 2-3 hours IF you can even get in the queue. Most times you just get a "we're too busy, call back later" message and they hang up on you. This service keeps trying until they get through. I calculated that my time was worth way more than spending an entire day repeatedly calling and waiting on hold.

This is such a good point about mortgages that people overlook! My brother runs an S-Corp and minimized his W-2 income, taking mostly distributions. He got denied for a home loan even though the business was profitable because the lender only counted his W-2 income. Had to restructure everything and wait two years for loan approval.

Exactly! I've seen this scenario play out repeatedly. Lenders typically want to see a 2-year history of W-2 income, and they heavily discount or completely ignore S-Corp distributions when calculating debt-to-income ratios. Another consideration is retirement planning. Your 401(k) contribution limits are based on your W-2 income, not distributions or 1099 income from your own company. If you're trying to maximize retirement savings, having more W-2 income allows for larger 401(k) contributions. These factors often outweigh any potential tax savings from minimizing W-2 income, especially when you consider the increased audit risk.

This is playing with fire. The IRS scrutinizes related-party transactions heavily, especially with S-Corps. They'll look at whether these "separate" businesses have economic substance beyond tax avoidance. Unless there's a genuine business purpose and you're offering the same services to other clients at market rates, this approach risks recharacterization and penalties.

You make a fair point about the risks. My suggestion isn't about creating a shell company just for tax purposes - that would definitely raise red flags. I was thinking more along the lines of a situation where someone genuinely has a separate consulting business with multiple clients, and their S-Corp happens to be one of those clients. The key factors are having multiple unrelated clients, charging market rates to all clients including the S-Corp, maintaining separate books and business operations, and ensuring the services provided are distinct from shareholder duties. Without these elements, you're absolutely right that it would likely fail IRS scrutiny.

Thank you for sharing your audit experience - this is exactly the kind of real-world perspective that's invaluable! Your point about the IRS having algorithms that flag unusual 1099 patterns is particularly eye-opening. I'm curious about the timeline - how long did the audit process take from start to finish? And did you have professional representation, or did you handle it yourself? I'm wondering if there were any warning signs beforehand that might have indicated the audit was coming, or if it seemed random. Also, when you mention "penalties and interest were significant," are we talking about just the additional payroll taxes owed, or were there separate penalties for the improper classification? This kind of detail really helps put the true cost of these arrangements in perspective.

This audit experience is incredibly helpful - thank you for sharing the details. As someone who's been considering a similar structure, your story is a real wake-up call about the risks involved. I'm particularly interested in what you mentioned about the IRS having "specific algorithms that flag S-Corps with unusual 1099 patterns." Do you know if there are certain thresholds or ratios that trigger these flags? For instance, if 1099 payments to shareholders exceed a certain percentage of total compensation or revenue? Also, you mentioned the audit focused on whether you were "acting in your capacity as a shareholder-employee." How did they make that determination? Was it based on documentation, interviews, or analysis of your actual work activities? I'm trying to understand what evidence they used to make their case. The penalty aspect is concerning too. Beyond the reclassified payroll taxes, were there accuracy-related penalties or other fines? And did this affect your ability to take distributions in subsequent years while the matter was being resolved? Your experience really reinforces what the other commenters have said about just structuring everything properly as W-2 compensation from the beginning, even if it costs more upfront.

This is exactly the kind of real-world experience that cuts through all the theoretical advice. I'm dealing with a similar situation right now and your audit story is making me seriously reconsider the approach my accountant suggested. A few follow-up questions if you don't mind sharing: How did the audit actually start? Did you receive a letter out of the blue, or were there preliminary inquiries? And when you say they have algorithms flagging unusual 1099 patterns, do you know if it's triggered by dollar amounts, percentages of total compensation, or something else? The "totality of circumstances" test you mentioned is particularly concerning because it sounds pretty subjective. Did they actually visit your office or interview employees, or was it all based on documentation review? Your point about the clean books being worth the extra payroll taxes upfront really resonates. The stress and uncertainty of an audit, plus the professional fees to handle it, probably cost more than just paying the payroll taxes correctly from the start.

This is exactly the expert perspective we needed in this thread! Your point about IRC Section 1372 automatically classifying active shareholders as employees is crucial - it cuts through all the confusion about "scope of duties" arguments. I'm particularly concerned about your observation regarding the $72K salary on $850K revenue potentially triggering reasonable compensation scrutiny. Could you elaborate on what the IRS typically considers reasonable compensation ratios for S-Corp shareholders? Are there industry benchmarks or safe harbors that apply to marketing/professional services firms? Also, when you mention structuring commissions as additional W-2 compensation, would this typically be done through a formal amendment to the employment agreement, or can it be handled through board resolutions? I want to make sure any changes are properly documented to withstand potential audit review. The original poster mentioned this is a family S-Corp - does that create any additional compliance considerations or put them at higher audit risk? I've heard the IRS pays extra attention to related-party transactions in closely-held businesses.

Thank you for this detailed professional insight! Your point about IRC Section 1372 really clarifies the legal framework here. I'm curious about the practical implementation - when you help clients transition from problematic 1099 structures to proper W-2 commission arrangements, what's the typical process? Specifically, do you recommend making the change immediately mid-year, or is it better to wait until the next tax year to avoid complications? And are there any special considerations for documenting the business purpose behind commission-based compensation to make it audit-proof? Also, regarding the reasonable compensation issue you mentioned - if someone is already potentially underpaying themselves on base salary, could adding legitimate commission-based W-2 income actually provide some protection by bringing total compensation closer to market rates? It seems like this could solve two compliance issues at once.

Great point about state-level compliance! California's ABC test is indeed much stricter than federal guidelines, and you're absolutely right that a 35% shareholder bringing in clients would fail the "outside usual course of business" prong almost automatically. Regarding retroactive fixes - this is actually more common than you might think. The cleanest approach is usually to file amended returns for the affected years, reclassifying the 1099 income as W-2 wages and paying the additional payroll taxes plus interest. Yes, it's expensive upfront, but it demonstrates good faith compliance if the IRS ever comes knocking. The key is documenting everything properly - board resolutions acknowledging the error, amended payroll records, and clear paper trail showing the correction was voluntary. Most CPAs who handle S-Corp compliance have dealt with these situations and can guide you through the process while minimizing audit risk. One advantage of proactive correction is that voluntary compliance generally results in much lighter penalties (if any) compared to getting caught in an audit. The IRS actually has programs that encourage taxpayers to come forward with these kinds of issues rather than trying to hide them.

This is exactly the kind of firsthand experience that really drives the point home! Thank you for sharing how you navigated this situation. Your decision to get clarity directly from the IRS was smart - there's nothing like getting the official position straight from the source. I'm curious about the performance bonus structure you ended up implementing. Did you set it up as a formal bonus plan with specific metrics and thresholds, or is it more discretionary based on results? Also, how did you document the business justification for the performance-based compensation to make sure it would hold up under scrutiny? Your point about the IRS increasing audits of S-Corps with unusual 1099 patterns is particularly concerning given the current enforcement environment. It sounds like the risks have only gotten higher since your accountant first suggested this approach. The peace of mind factor you mentioned really resonates with me - the stress of potentially facing an audit and having to defend questionable tax positions probably isn't worth whatever savings might be achieved. Did you find that the restructured W-2 approach ended up costing significantly more than the original 1099 plan would have, or was the difference smaller than you initially expected?

This discussion has been incredibly eye-opening! As someone new to S-Corp structures, I had no idea how strict the IRS was about shareholder-employee classifications. The real audit experiences shared here are genuinely scary - it sounds like the IRS has sophisticated systems to flag exactly these kinds of arrangements. What really concerns me is how common this seems to be. If accountants are regularly suggesting these 1099 structures to clients, there must be a lot of S-Corps out there unknowingly putting themselves at audit risk. The stories about algorithms flagging unusual patterns and automatic compliance reviews make it sound like it's not a matter of if you'll get caught, but when. I'm also struck by how the "reasonable compensation" issue keeps coming up alongside this. It seems like many S-Corp owners are trying to minimize their W-2 income to save on payroll taxes, but then end up creating multiple compliance problems instead of just one. The mortgage and retirement planning impacts mentioned earlier just add more reasons to structure things properly from the start. For someone like the original poster who's already been advised to do this, it sounds like the best move is to get a second opinion from an S-Corp specialist and restructure everything as W-2 performance compensation before implementing anything. The peace of mind alone seems worth the extra cost.

This legal perspective really puts everything into context - thank you for sharing the specific case citations and penalty details! The Watson v. Commissioner reference is particularly helpful because it directly addresses the argument that many accountants seem to be making about "different duties" somehow creating a separate contractor relationship. The 40-50% total cost figure you mentioned (additional taxes plus penalties plus interest) is a real eye-opener. When you factor in the professional fees to handle an audit and the time spent dealing with it, the original "savings" from avoiding payroll taxes becomes completely illusory. I'm curious about the documentation you mentioned for performance-based W-2 compensation. What specific elements should be included to make this audit-proof? Should there be formal board resolutions, written performance metrics, or amendments to employment agreements? And how detailed should the business rationale be - is a simple board minute sufficient, or do you recommend more comprehensive documentation? Also, given your experience with post-TCJA enforcement, have you noticed the IRS focusing more on certain dollar thresholds or percentages when selecting S-Corps for audit? The data analytics angle you mentioned suggests they're using more sophisticated targeting than just random selection. Your advice about ensuring total compensation meets reasonable standards is spot-on - it seems like many S-Corp owners create multiple compliance issues by trying to minimize W-2 income across the board rather than just structuring everything properly from the start.