S Corporation Commission Trap: IRS Audit Risk Explained

We continue to see aggressive advice circulating about routing personal commissions through an S corporation to reduce self-employment tax. This strategy sounds attractive, but it fails under long-standing tax law and creates significant audit risk.

Consider a common setup: An individual earns commissions under contracts issued in his personal name. He holds the required state license individually, and payors issue Forms 1099-NEC to his Social Security number. Despite these facts, he attempts to shift the income into an S corporation by charging a “management fee” equal to most or all of the commissions, or by directing payors to deposit the commissions directly into the S corporation’s bank account.

Neither approach works.

Tax law focuses on one central question: Who earned the income? When income arises from personal services, the individual who performs the services and controls the earning of that income must report it. Labels, internal invoices, and bank routing do not change that result.

A 100 percent management-fee approach collapses quickly under scrutiny. The IRS compares the 1099s issued to the individual with the tax return and sees commissions wiped out by a related-party fee. Examiners routinely reclassify the commissions as the individual’s Schedule C income, deny the fee, and unwind the S corporation reporting. The result places the income back where it started—subject to self-employment tax—along with interest and penalties.

Routing commissions by ACH directly into the S corporation’s account fares no better. The contracts remain in the individual’s name. Licensing records still identify the individual. The 1099s still list the individual as payee. The IRS simply treats the deposits as income constructively received by the individual and then transferred to the corporation. This tactic often worsens the audit narrative by suggesting intentional income shifting.

A management fee can work only when the S corporation performs real, measurable services and charges a reasonable, supportable fee for those services. The fee must compensate administration, staffing, marketing, and/or infrastructure—not attempt to transfer ownership of the commissions themselves.

Effective S corporation planning requires the corporation to sit legitimately in the income stream, with contracts, regulatory approval, and reporting aligned to that structure. Anything else invites predictable adjustments.