Employer Wants to 1099 Contractor, not Contractor's S Corporation

[Bubba Jimmy]

The facts are very clear. I have personally audited very similar situations. The company contracted with the individual, not the corporation. The individual provided his social security number to the company, probably on a form W-9. The individual personally provided services to the company. The company then paid the individual personally, and issued form 1099-MISC with non-employee compensation reported in box 7.

The individual therefore MUST file Schedule C with his personal tax return. There is no way around that. If he pays the money over to the S corp and takes that as a deduction on his personal tax return, that is fraudulent. Why? Because the S corp has no legitimate role in the transaction. The only reason I can see for doing this is to try to obtain tax treatment available to the corporation that is not available to the individual. If it was this simple to avoid the rules, why does anyone file as a sole proprietor and pay the SE tax on the full amount of profit from their business activity.

Bottom line is that it is easy for anonymous people to post any kind of scheme they like on a message board. They are not the one who will have to answer for any allegation of fraud.

jk is likely right, the company refused to do business with the S corp and agreed to the deal only if the individual personally provided the service for personal liability purposes. They refused the proposal to do business with the corporation. If the individual did something the caused harm, they wanted to be able to hold him accountable for his injurious action. That was a term of the agreement. That was the meeting of the minds, and the basis on which the work was performed. There is no way to shuffle paper to change the facts.

[SChinFChin]

First, if OP is concerned with anonymous people posting any kind of scheme on a message board, then he shouldn't be posting questions on a message board to begin with. On the other hand, like most intelligent people I know, as he sounds like one, he can take ideas here as food for thought and then further discuss them with his attorney or CPA.

As I said, if it is a big big issue the S Corp not legitmate vis a vis this particular client, he can always go to the alternative I outlined, as I did with my rental management company, prepare a management contract on what he would do, how much it is, and deduct it off his schedule C, and that would be the income for the S Corp. He has to make sure he brings in enough income to cover his expenses. His client has nothing to do with this arrangement, so people can yell all they want about fraudulent shuffling of papers, but the bottomline is, he is still paying taxes on the S Corp income if he diverts too much, and no one is harmed.

As to personal liability issues, there are ways of handling it, such as a side agreement with the client that he would be responsible. But if the company has a hard rule on paying all IC's personally, such as we don't do this for anyone, he should consult a CPA, should be able to flow something through an S Corp as I outlined.

[Bubba Jimmy]

A sole proprietorship cannot be used as a pass-through entity for an S corporation. It is a clever scheme, but you have no idea what you're talking about and to give advice in such a matter is irresponsible. If you have some authoritative source advocating such a scheme, post it. Otherwise, honestly, you are not giving helpful advice, you are advocating fraud. No one is harmed? The whole purpose of this scheme is to evade taxes, and that makes it criminal.

[SChinFChin]

A sole proprietorship cannot be used as a pass-through entity for an S corporation. It is a clever scheme, but you have no idea what you're talking about and to give advice in such a matter is irresponsible. If you have some authoritative source advocating such a scheme, post it. Otherwise, honestly, you are not giving helpful advice, you are advocating fraud. No one is harmed? The whole purpose of this scheme is to evade taxes, and that makes it criminal.

Evade what taxes?? If you do the math, under current tax law, he pays the same taxes, particularly SE taxes whether the income falls onto the S Corp or not, so it is NOT fraud if he is not paying any less in taxes. I pay management fees to own management company for years, a legitimate business expense, and my CPA haven't yet yelled fraud.

As I said, this issue is complex enough that OP should consult his own CPA or attorney, instead of relying on a few guys ranting and raving on a message board.

[Bubba Jimmy]

What do you believe these "tax benefits of the S corp" mentioned by the OP are? You say he pays the same taxes, but he seems to think otherwise. What is it that would cause him to jump through all the hoops if not to obtain a tax benefit? I know you are not that naive.

But, for the sake of the board I'll spell it out. If an owner of stock in an S corp takes out divedends as a return on investment, those payments are not subject to social security and medicare taxes. Only the amount paid to an employee of the corporation on a W-2 are subjected to the employment taxes. Now, it is fine to pay one's self a "reasonable wage" when an officer/shareholder provides services to the corporation and take the rest as shareholder ROI or dividends if you will. But not under the circumstances presented in this case. And, if you consult a CPA who tells you this scheme is okay, I would recommend that you run very fast from such a person because such advice, if followed on a large enough scale, could land you in a federal prison.

[SChinFChin]

If OP made $100,000, transferred the ENTIRE amount to his S Corp, then said only $40,000 of it is paid out in wages, then you would be right.

On the other hand, with my management company setup that I use, the purpose is just to do tax writeoff of expenses. So if my expenses only runs $10,000/year, I pay my own management company $10,000 a year, the management company has $10,000 in income, $10,000 in expenses, and zero left over to pay in wages, so there is no SE taxes to pay at all. So there is no fraud.

If the expenses are not that great, it's easier to include it in his schedule C. We don't know much of what OP does, what is tax writeoff situation is, so all we're doing here is speculating.

[danmassi]

Well, my apologies to the parties who have become so interested in this posting. I should have been paying closer attention over the past couple of days, but I wanted to see my kids whom I have hardly seen due to working myself to death over the last couple of months...

So here are some more facts to address some of the inquiries posted by the responders:

- I was originally an employee of the company with which i now split profits from deals - that's why they have my personal info.

- The company decided to go to a totally commission-based compensation system. Worse, they now charge me rent and overhead expenses to remain "affiliated" with them. I accrue liabilities to them until I close a deal, then I must reimburse them for "expenses" I "accrued" (a fixed monthly charge).

- On top of this, I need to pay, out of my own pocket, travel, entertainment, lodging, you name it, in the pursuit of business. This is how a business operates, isn't it? Expenses are paid from revenues before any calculation of profit can be made....

- OF COURSE I want to minimize my SE taxes. I d not wish to evade them, but I MOST CERTAINLY do not wish to have 100% of REVENUES treated as SALARY, especially when so much of my "revenue" will be eaten up by direct operating expenses. Perhaps I don't truly understand the differences between a Schedule C sole-proprietorship and an S-Corp, but I was under the impression that a check made out to me is all subject to SE Taxes, which would be a load of crap. Whoever wants to keep using the phrase "tax evasion" clearly doesn't understand this situation and what I am trying to achieve/avoid...but perhaps I don't fully understand either.

- I am in the securities business. FINRA insists on a broker dealer writing checks (for securities related business) only to individuals who themselves are "registered", and not to a "company", unless that company is also a registered broker-dealer (which I don't intend to do - that actually conflicts with other FINRA regulations, of course). However, FINRA would not see IRS 1099s. For a while my company was issuing me checks to "My Name dba My Company" but has since decided not to do that anymore. This is actually an issue regarding conflicting and to many regulations of small businesses. I am truly, in every sense of the word, a free-lance, independent contractor, running my own business, that has ongoing expenses that must be paid out of revenues. (Someone also mentioned insurance - the same also applies, I will lose my "group" coverage in CA if I can't maintain my S Corp as its own entity, yet another unfair restriction due to a regulator's inability to properly apply the rules).

The bottom line is this: FINRA does not want broker-dealers making payments to other "companies" in order to prevent such things as political contributions (pay-to-play) in my business. That's fine; however, they are interfering with a compensation arrangement that has nothing to do with any such thing. I need to run a business; co-mingling my business finances and personal finances on a schedule C is not something I want to do. I need to hire some assistants and operate the business as separately as possible from my "person", but a misguided FINRA regulation and a nervous company I work with (not FOR), are not helping matters.

So I suppose I have a new question: are all Schedule C revenues subject to SE Tax? Or are ordinary business expenses and deductions allowed? I would not be happy about losing the S-Corp dividend benefit, and it's a load of CRAP if some regulator will force me into a business model that is not my choosing, but I do recognize that something are not worth the price, and an extra extortion, I mean tax payment of $20,000 or so might be cheaper than fighting this issue.

I don't know if this cleared anything up for anyone, but I am not trying to evade taxes nor evade regulation. I want to be treated as a business operator, which is what I am, under the tax code, and be left to get my deals and run my business ethically and responsibly, but not be PENALIZED nor DENIED the same tax benefits as any other business simply because I am in a specific industry the the government doesn't know how to properly regulate, so they are operating with a hammer instead of a scalpel.

So Yes, I AM looking for creative solutions as this situation is created by a bunch of patently unfair regulations and UNAMERICAN restrictions to how I wish to operate my business, which is truly a business in every sense of the word. When I am in a position to have enough capital to open my own Broker-Dealer, then perhaps I can extricate myself from this current relationship, but for now, I have no choice but to "transact" my deals through a registered Broker-Dealer, and for this it is costing me more than a pound of flesh. If I was getting a draw, expense reimbursements, insurance coverage, anything akin to WORKING for the company who writes the checks, which represent MY MONEY that I EARNED, DESPITE their existence, not because of it (which is another story entirely), then I would not even have posted here, and I'd be happy to operate without any particular creativity. So if anyone can lend me a hand to help lift the heavy-handed burden of government from my small-business's throat, I'd appreciate it.

Any yes, avoidance of "raising red flags" is always preferred, so I do appreciate the replies that were nervous about the offsetting Schedule C entries, although I have heard that strategy before. At the end of the day, if I am not cheating, but do in fact raise a red flag, then I will have to endure an audit and just be sure to have excellent records to justify my approach.

Thanks again to all who posted with thoughtful replies.

[SChinFChin]

I'm glad you read through our discussions. Let me put a few thought down while I have the time today.

Your SE tax would be based on your net profits, and in your case, your 1099 earnings less your elegible expenses, which would include auto, T&E, rent, health insurance etc., pretty much a "profit and loss" statement which is the schedule C. You then go on to figure your SE taxes on another schedule (the SE), and then back to the 1040. I don't intend to go into the intricacies of filing the tax returns here, so I'll go into some of the higher level issues.

I set up my management company structure when I left my employed job, gone into my own business, and when my COBRA was about to run out. When I called an insurance broker about getting health insurance as an individual, he pretty much laughed and told me the rates are ridiculous compared to if I bought it as a business, coverage terrible, as he can do much better procuring it through a group plan as a business. I was doing software consulting where the revenues are erratic, where I had an S Corp., but I also did property rentals, where the revenues are steady and growing, but no corporate entity. After review of the situation, I went out and set up a C Corp for my property rentals, and obtained my insurance that way.

And later on, the idea is if I expand, hire people, and need workman's comp, unemployment insurance, it's easier to pay employees, obtain insurance as a company, with the added attraction that it's all separate from my personal income tax returns. I can also add employees easily under a company health plan.

You mentioned that your broker dealer cannot issue checks to a company, but only to you personally, and you plan not to be a broker dealer. What it means is this is ideal that if you set up a mangement company, you can legitimately issue checks to it to this company so it can in turn cover expenses, such as rent, T&E, auto, health insurance, and later on if you hire staff, salaries, WC, UI etc. when it comes to that. What you'll need to do is estimate how much you'll need to flow to it each month to cover all of these expenses, and have the cash on hand to issue the checks.

This management fee would be charged under your schedule C, an expense to you personally, and after that, the management company would pay all the bills. To make it clear and concise, and all legal and proper, write up a management contract on how this is to work, and a corporate resolution.

By doing it this way, all of your 1099 income would still come through on your schedule C, then netted out by payments to your managment company, and less any other payments not through your management company. You can probably inflate the fees a bit, get more of your income to the management company, but you might run afoul of IRS audits, as was alreday pointed out, so keep it as conservative as possible.

Get a attorney and CPA to go through this with you. I done a little research on the net myself before going into mine, asked my CPA the right questions, so he is on board. I wrote the management contracts and corporate resolutions myself, but yours is more complicated than mine, so if it was me, I would have someone help me write it.

[Bubba Jimmy]

To address the problem you have actually articulated, all you need to do is file Schedule C with your 1040 tax return. All of your business expenses for rent, office supplies, travel, E&O insurance, and other operating expenses can be deducted to reduce the amount of reportable self-employment income. Let's say they pay you $150,000 in 2011. Let's further say that all the expenses you are concerned about amount to $80,000. Deduct them on Schedule C and the amount you'll pay the SE tax on is only $70,000, not the gross amount you were paid. You can also deduct vehicle mileage, amounts paid to subcontractors, and any other legitimate business expense. You health insurance can be deducted in full as an adjustment to income of page 1 of your 1040 regardless of whether you itemize deductions on Schedule A or not. You seem to be under the misimpression that you will have to pay the SE tax on the total income reported in box 7 of the 1099-MISC. That is most certainly not the case.

Perhaps you should consult a tax professional. You don't sound like you've done this sort of thing before. I cannot imagine how a management agreement with your S corp, and shuffling income to an entity that performed no services to anyone, could possibly help you. I can certainly see how it could cause you serious problems.

I will just reiterate, encouraging a person who doesn't even understand that they can deduct business expenses on Schedule C to reduce their SE tax to try such a scheme is utterly irresponsible.

[SChinFChin]

Perhaps you should consult a tax professional. You don't sound like you've done this sort of thing before. I cannot imagine how a management agreement with your S corp, and shuffling income to an entity that performed no services to anyone, could possibly help you. I can certainly see how it could cause you serious problems.

I will just reiterate, encouraging a person who doesn't even understand that they can deduct business expenses on Schedule C to reduce their SE tax to try such a scheme is utterly irresponsible.

I agree with you here, OP should see a professional.

My situation with health insurance some years back was similar to OP's. My insurance agent told me shedule C's or E's don't count as far as he's concerned with getting a company health insurance plan. Tells me, "come up with an 1120 or 1120-S, then we're talking". And I haven't figured out how to make up an 1120 return, except forging one, without an entity that provides no services to anyone, so if you have an idea how, tell me.

I haven't looked into Obamacare, so I don't know if it makes a big difference at this point. Back then, it was a lot more if I was getting coverage as an individual in NY, lots lots more. So it's not the issue that health insurance could be deducted off a schedule C, it's the issue that I can't afford one that I can deduct off the schedule C.