S CORP Shareholder-Employee Form 1099 or W-2
Can a Shareholder-Employee of an S Corp Be Issued a Form 1099-MISC? You Need to Understand the Tax Consequences When an Owner of S Corp. Improperly Receives a 1099-MISC
Fact Pattern: PA resident purchases goods on the Internet that are subject to PA sales tax. The vendor selling the goods on the Internet is not registered with the PA DOR because the vendor lacks nexus in PA. There is no PA sales tax charged by the vendor on the sale. The PA resident was required to remit PA’s use tax (6% – the same rate as the PA sales tax) on the taxpayer’s PA-40). The taxpayer’s remittance of the use tax was on the honor system – PA really had no means to check if the taxpayer remitted all of the use tax that was due. For PA, with Delaware next door without a sales tax, it became even more of a challenge.
Assume that a single shareholder (owner) of an S Corporation receives compensation for his services and either fails to issue himself a W-2 or decides to issue himself a Form 1099-MISC instead of Form W-2. The motivations for not following the law are usually to (1) avoid penalties related to the late remittance of payroll taxes associated with a W-2 filing; (2) avoiding the expense of engaging a payroll processing company; and (3) the flawed thinking that as long as the compensation is reported to the IRS, it makes no difference how the compensation is reported to the IRS because the shareholder will pay income taxes and self-employment taxes under either scenario.
This thinking is flawed because IRS FS-2008-25 states that corporate officers are specifically included within the definition of an employee for FICA (Federal Insurance Contributions Act), FUTA (Federal Unemployment Tax Act) and FIT (federal income tax) withholdings under the Internal Revenue Code.
Generally, an officer of a corporation is an employee of the corporation. The fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages.
The one known and limited exception to not paying a shareholder/employee W-2 compensation is discussed in our Feb. 21, 2017 blog post.
Let’s discuss some of the perils a business owner faces by ignoring the requirement to issue the officer/shareholder a W-2. IRS audits of payroll taxes is becoming more common. If compensation is not reported as wages, the IRS can assess:
- Unpaid payroll taxes for multiple periods as the statute of limitations starts when returns are filed;
- Interest on the unpaid payroll taxes:
- Penalties for failure to file quarterly Form 941;
- Penalties for failure to timely pay the tax withholdings to the IRS;
- Penalties for failure to file and issue Form(s) W-2;
- Back taxes for state and local payroll filings, intgerest, and penalties;
AND, there is more bad news . . . .
- What many employers do not realize is that even though the “independent contractor” who is paid via a Form 1099 pays all of the self-employment, Social Security and Medicare taxes, that the payment of self-employment taxes is a different tax than payroll withholding taxes even though they are both taxed at 15.3%. Thus, the employer could still be found liable for payment of the employer and employee share of Social Security and Medicare taxes (Western Management case).
- The Tax Cuts and Jobs Act introduced the Qualified Business Deduction which uses “reasonable compensation” to determine business profits which in turn . . .
- Causes the IRS to place more emphasis on audits of businesses to determine if the shareholder-employee is being paid a reasonable compensation. If it is determined that a reasonable compensation is not being paid, those distributions made to the shareholder-employee run the risk of being reclassified as hidden compensation resulting in the penalties and interest assessments discussed above.
While almost everyone always focuses on federal taxes, don’t forget those state auditors. States generally prefer wages over self-employment income because wages are subject to state unemployment taxes, another source of revenues for the states.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.