Can I 1099 Myself From My C Corp?
For C Corp owners, payment for services is governed by employee tax rules. Understand the required structure for compensation versus distributions from profit.
As the owner of a C Corporation, you cannot pay yourself for your services with a Form 1099. For any work you perform as an officer of your C Corp, the Internal Revenue Service considers you an employee. This classification is a legal requirement, not a choice.
Compensation for your labor must be processed through payroll and reported on a Form W-2. The distinction between an employee and an independent contractor is a matter of law. Attempting to classify yourself as an independent contractor can lead to significant tax complications and penalties.
The Employee Status of a Corporate Officer
A C Corp owner cannot use a Form 1099 for services because the IRS defines them as a “statutory employee.” Corporate officers are explicitly listed in this group. If an officer performs any service for the corporation and receives payment for it, they are automatically considered an employee for employment tax purposes. This applies to Federal Insurance Contributions Act (FICA) taxes and Federal Unemployment Tax Act (FUTA) taxes.
This statutory classification overrides the common law tests used to differentiate between employees and independent contractors, which examine factors like behavioral and financial control. An owner-operator of a C Corp has significant control over these aspects, which points toward an employee relationship even without the specific rule.
The IRS created this designation to prevent individuals integral to a company’s operations from being misclassified to avoid payroll taxes. By performing duties as an officer, you act as an agent of the corporation, and any payment for these services is considered wages. This is not an optional designation.
The only exception is if an officer performs no services, or only minor ones, and receives no compensation. In such a rare case, they would not be considered an employee. However, any owner actively involved in running the business is an employee and must be paid via a W-2.
The Correct Method for Owner Compensation
An owner-officer must be paid a salary through a formal payroll system. This process requires adherence to the IRS concept of “reasonable compensation.” The Internal Revenue Code permits a business to deduct a reasonable allowance for salaries, and the IRS enforces this to ensure C Corps do not disguise nondeductible dividends as deductible salaries.
Determining a reasonable amount is based on what a similar business would pay for comparable services. The IRS considers several factors:
- The owner’s duties and responsibilities
- The owner’s level of experience and training
- The time the owner devotes to the business
- The company’s financial performance
It is advisable to research industry benchmarks and document the basis for the compensation in corporate minutes to establish a defensible salary.
Once a salary is determined, it must be processed through payroll. The corporation is responsible for withholding federal and state income taxes and the owner’s share of FICA taxes, which is 6.2% for Social Security and 1.45% for Medicare. The corporation must also pay the employer’s matching portion of these FICA taxes and is responsible for paying FUTA taxes. At the end of the year, the corporation must provide the owner-employee with a Form W-2 summarizing the total wages paid and taxes withheld for their personal tax return.
Understanding Shareholder Distributions
Beyond salary, a C Corp owner can receive money from the company through shareholder distributions, known as dividends. This represents a return on the owner’s investment, not payment for labor. A dividend is a distribution of the corporation’s after-tax profits to its shareholders.
The primary distinction is their tax treatment. An owner’s salary is a deductible business expense for the corporation, which reduces the company’s taxable income. This makes salary an efficient way to move money out of the corporation from a corporate tax perspective.
Dividends, however, are not a deductible expense for the C Corp. They are paid from the corporation’s net profits after the company has already paid corporate income tax on those earnings. This leads to “double taxation.” The corporation first pays tax on its profits, and then the shareholder pays personal income tax on the dividend they receive.
Consequences of Misclassification
Paying a C Corp owner with a Form 1099 instead of a W-2 carries financial risks. If the IRS discovers this misclassification, it will recharacterize all payments as wages. This action makes the corporation responsible for all employment taxes that should have been paid.
The most immediate consequence is the liability for back payroll taxes. The corporation will be required to pay both the employer’s share of FICA taxes and the employee’s share that it failed to withhold. This means the company is responsible for the full FICA tax burden on all misclassified payments.
On top of back taxes, the IRS will impose significant penalties. These can include penalties for failure to file payroll tax returns, like Form 941, and failure to pay the required taxes on time. Interest will also accrue on the unpaid tax liability from its original due date. For a willful misclassification, penalties can be more severe and may include substantial civil penalties.