Key Takeaways

  • An S Corp is a business structure that provides tax benefits and liability protection, while 1099 refers to a tax classification for independent contractors.
  • The IRS generally does not require 1099-NEC forms for payments to S Corps, but there are exceptions (e.g., legal and medical services).
  • S Corps offer tax savings by allowing business owners to split income into salary and distributions, reducing self-employment tax liability.
  • Independent contractors using 1099 status must pay self-employment taxes but can deduct a wide range of business expenses.
  • Misclassifying a worker as a 1099 contractor when they function as an employee can lead to IRS penalties.
  • Choosing between an S Corp and 1099 status depends on factors like income level, administrative capacity, liability concerns, and long-term business goals.

S Corp vs 1099

When comparing an S corp vs 1099, the two do not have to be mutually exclusive. The IRS requires companies to use 1099s on all employees working as independent contractors, but S corps come with certain restrictions and benefits. S corps are allowed to reduce self-employed taxes that are paid.

Small and large businesses use various contractors and service providers to accomplish certain tasks that a company cannot or will not do. Such tasks may include the following:

  • Strategic planning
  • Construction
  • Analysis
  • Streamlining operations

Mistaken Impressions

Many small business owners and others falsely believe that independent contractors work for less money and pay more in taxes. Such misconceptions stem from the following:

  • W-2 Employees: Many employers withhold self-employment taxes, and the employer pays half of those taxes, with the employee paying the remaining balance. Self-employment taxes are also called payroll taxes in the form of Medicare, Social Security, and FICA taxes. Therefore, W-2 employees do not see the full amount of taxes they are paying.
  • Employee Conversion: Employees may be surprised by much how much they’ll pay in taxes if he or she converts from a W-2 to 1099.

IRS Scrutiny and Worker Misclassification Risks

Misclassifying a worker as an independent contractor (1099) when they should be treated as an employee (W-2) can lead to serious legal and financial consequences:

  • IRS penalties may include back taxes, unpaid payroll taxes, interest, and fines.
  • State labor departments may impose additional penalties for labor law violations.
  • Factors the IRS uses to determine classification include:
    • Behavioral control: Does the business control how the worker performs the job?
    • Financial control: Are expenses reimbursed, and is the worker free to seek other clients?
    • Relationship type: Are there written contracts, benefits, or long-term commitments?

To avoid penalties, businesses should carefully assess whether a worker meets the criteria for independent contractor status before issuing a 1099.

1099 Positives

The good thing is that 1099 workers will pay fewer taxes than the amount received through a W-2 status because of deductions. In addition, S corps are allowed to reduce self-employed taxes that are paid. The creation of a corporation may complicate tax filing procedures, but the added fees and complexities are worth it when considering the tax savings involved.

  • Note: To get the best out of an S corp and 1099, you should hire a tax professional who can guide you through the process.

According to the IRS, a 1099 employee is an actual business owner, meaning that he or she may deduct business expenses from the gross amount noted on the 1099 form. Such expenses may include:

  • Mileage
  • Home-based internet
  • Phone

S Corp Tax Advantages vs 1099 Deductions

When evaluating S Corp vs 1099 benefits, it’s crucial to understand the tax-saving opportunities each classification offers.

S Corporation tax advantages:

  • Ability to pay yourself a "reasonable salary" and take additional profits as distributions, which are not subject to self-employment tax.
  • Potential to save thousands annually on self-employment taxes if your net income is substantial.
  • Pass-through taxation prevents double taxation, unlike C Corps.

1099 independent contractor deductions:

  • Can deduct all ordinary and necessary business expenses, including travel, marketing, home office costs, and professional services.
  • Self-employment tax applies to all net earnings, but many deductions can lower your taxable income.

Generally, if your net income exceeds $40,000–$50,000 per year, forming an S Corp may result in significant tax savings despite increased administrative responsibilities.

Corporate Differences

The main difference between C and S corp 1099 reporting pertains to tax guidelines and how officers are designated. For instance, larger companies with many owners are usually created as C corps. The shareholders (owners) receive compensation, known as dividends, but only if the corporations choose such a structure.

C corps are taxed as live entities and pay federal, state, and local taxes on net income. A corporation may opt to pay shareholders via declaration and pay the dividends from post-tax net profits.

If a C corp opts to issue dividends, it may submit 1099-DIV documents to the IRS and shareholders. A 1099-DIV functions in the same way as a W-2, but it is reserved for independent contractors. Therefore, the IRS will exempt corporations, but will not apply the same exemptions for LLPs and LLCs.

Certain payments, such as those $600 in lawyer fees or cash expenses, mandate a 1099-MISC issuance. The following healthcare and medical costs over $600 to the following places also require 1099-MISC forms:

  • Medical facilities
  • Physician groups
  • Medical providers

Administrative Burdens of an S Corp vs 1099

Operating as an S Corp comes with additional compliance and filing requirements compared to working as a 1099 contractor:

S Corporation requirements:

  • Must file an S Corporation tax return (Form 1120-S) annually.
  • Must run payroll and issue W-2s to shareholder-employees.
  • Must maintain corporate formalities such as annual meetings and minutes.
  • Requires separate business bank accounts and bookkeeping systems.

1099 contractor simplicity:

  • Reports income using Schedule C attached to Form 1040.
  • No payroll setup required.
  • Less paperwork and fewer regulatory obligations.

While 1099 status is easier to manage, S Corps may be worth the extra effort for individuals earning high self-employment income who want to reduce tax liabilities.

Corporate Guidelines

C and S corps must submit and report non-employee pay that’s over $600 during a calendar using 1099-MISC forms. Also, part and full-time worker compensation must be reported to the payroll department, which is also responsible for withholding state, local, and federal taxes every time employees are compensated.

The mandates on corporations also pertain to S corp, which are corporations that choose an S status classification under IRS guidelines. In essence, S corps dodge double taxation associated with C corps. This is possible due to pass-through taxation, where losses and profits shift away from the business to shareholders to file on their personal tax returns.

Reporting Duties

The shareholders would then pay taxes based on his or her percentage in the company. For instance, take an S corp with five shareholders, where a sole person owns 60 percent, while the others own the remaining 10 percent. If the business made over a $20,000 net profit, the person owning majority shares adds $12,000 (60 percent) to his personal tax returns, and the others would add $2,000 (10 percent) to their tax returns.

  • Note: S corps business does not pay business taxes.

The IRS restricts shareholder numbers and stock classes, but such limitations do not affect an S corp’s treatment according to 1099 guidelines.

When Do You Need to Issue a 1099 to an S Corp?

Although the IRS generally exempts S Corporations from receiving Form 1099-NEC, there are key exceptions to this rule. You must issue a 1099-NEC to an S Corp if the payments fall into the following categories:

  • Legal services: All payments made to attorneys (even those operating as S Corps) must be reported using Form 1099-NEC or 1099-MISC, depending on the nature of the payment.
  • Medical and healthcare payments: If you pay an S Corp for medical or healthcare services totaling $600 or more, Form 1099-MISC is required.
  • Payments for fish purchases or certain crop insurance proceeds: Specific industries may trigger mandatory reporting even when the recipient is an S Corp.

To determine whether a business is an S Corporation or qualifies for exemption, you can check Box 4b of IRS Form W-9, which asks the recipient to specify their tax classification.

Frequently Asked Questions

  1. What’s the main difference between an S Corp and a 1099 contractor?
    An S Corp is a business entity that offers liability protection and tax advantages, while a 1099 contractor is a self-employed individual who receives income reported on a 1099 form.
  2. Do S Corps receive 1099 forms?
    Generally, S Corps do not receive 1099-NEC forms unless the payment is for legal, medical, or other exempted services.
  3. Should I form an S Corp if I’m an independent contractor?
    If you're earning over $40,000 annually as a contractor, forming an S Corp may reduce your self-employment tax burden—but it comes with added administrative duties.
  4. What happens if I misclassify a worker as a 1099 contractor?
    You may face IRS penalties, including back taxes and interest, if a contractor is later deemed an employee.
  5. Can I be a 1099 contractor and own an S Corp?
    Yes, you can operate as an S Corp and pay yourself through payroll and shareholder distributions while still performing contract work.

To learn more about an S corp vs 1099, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s lawyers will explain the basics of 1099 issuance, and whether a W-2 or 1099 structure would be best for your business. In addition, they will provide assistance as you file taxes so you can take full advantage of S corp benefits.