An incorporated individual is a solo professional who forms a corporation and provides services through it rather than working as a sole proprietor, becoming the corporation’s sole shareholder, director, officer, and employee at the same time. Clients contract with and pay the corporation; the corporation then pays you a salary. The structure gives you a liability shield, opens up better retirement and payroll-tax planning, and pulls you into a specific set of IRS rules for personal service corporations, along with corporate formalities you have to keep up year after year.
How the Structure Works
The point of the arrangement is legal separation. Once the corporation exists, the law treats it as its own person. It signs contracts, holds bank accounts, bills clients, and owes taxes in its own name. You draw a W-2 salary from it as an employee. Depending on the field, the same setup goes by different names: loan-out corporation in entertainment, professional corporation in medicine and law, personal service corporation in the tax code.
That separation creates the corporate veil, a barrier between the corporation’s obligations and your personal assets. If the corporation is sued or defaults on a debt, creditors generally cannot reach your house or personal accounts. Generally. The protection depends on you actually running the corporation as a corporation, and courts will disregard the veil where the separation is only on paper.
How the IRS Classifies You
Most one-person service corporations get classified by the IRS as personal service corporations, and that classification carries specific tax consequences. The IRS applies two tests, and both have to be met.
The function test looks at what the corporation does. It applies when the corporation’s main activity is performing services in one of eight fields: health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, or consulting. The test is met when more than 20 percent of the corporation’s compensation costs go to personal services performed by employee-owners.1Internal Revenue Service. Entities 5
The ownership test requires that employee-owners hold more than 10 percent of the corporation’s outstanding stock by fair market value on the last day of the testing period.1Internal Revenue Service. Entities 5 When you own 100 percent, this is automatic.
Three consequences of that classification matter in practice. First, personal service corporations must use a calendar tax year unless they can show a legitimate business purpose for something else, and deferring the owner’s income does not qualify.2Office of the Law Revision Counsel. 26 USC 441 – Period for Computation of Taxable Income Second, passive losses inside the corporation cannot offset service income. Other closely held C corporations can use passive losses against active business income; personal service corporations are excluded from that exception, and unused losses carry forward but stay usable only against passive income.3Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited Third, Section 269A lets the IRS reallocate income and deductions between the corporation and the owner if the corporation performs substantially all of its work for a single client and the principal purpose of the arrangement is to avoid or reduce federal income tax.4Office of the Law Revision Counsel. 26 USC 269A – Personal Service Corporations Formed or Availed of to Avoid or Evade Income Tax If you set up the corporation mainly to convert what would be sole-proprietor income into something taxed more favorably, this is the tool the IRS uses.
C-Corp or S-Corp: The Choice That Drives Everything Else
A new corporation defaults to C-corporation status, and that default is usually wrong for a solo professional.
A C corporation pays a flat 21 percent federal tax on its taxable income after deducting expenses and salaries.5Office of the Law Revision Counsel. 26 USC 11 – Tax Imposed Your salary is deductible, so you can zero out corporate income by paying yourself everything, but anything left inside gets taxed at 21 percent and then taxed again when you take it out as a dividend. For a one-person service business with no reason to build up retained earnings, double taxation eats the benefit.
An S corporation solves the double-tax problem. It pays no federal income tax at the corporate level. Profits and losses pass through to your personal return on a Schedule K-1, and the corporation files an informational Form 1120-S. The bigger prize is on employment tax. A sole proprietor owes self-employment tax of 15.3 percent (combined Social Security and Medicare) on all net business income. An S-corp owner pays that 15.3 percent only on the W-2 salary; distributions of remaining profit are not subject to it. On $200,000 of net income where the salary is $120,000, the $80,000 distribution avoids roughly $12,000 in employment tax.6Internal Revenue Service. S Corporation Employees, Shareholders and Corporate Officers
You elect S-corp status by filing Form 2553 with the consent of all shareholders. A calendar-year corporation generally files by March 15 of the year the election is to take effect, with the deadline moving to the next business day if March 15 lands on a weekend. A new corporation must file within two months and 15 days of formation. Miss it and Revenue Procedure 2013-30 provides automatic late-election relief if you file within three years and six months. S corporations have to be domestic, cannot have more than 100 shareholders, are limited to one class of stock, and can only be owned by individuals, estates, or certain trusts. For a solo owner, none of these are usually an issue.
One caution for high-earning professionals in the fields that trigger personal service corporation status. The Section 199A qualified business income deduction can give S-corp owners up to a 20 percent deduction on pass-through income, but health, law, consulting, accounting, and the other listed fields are designated specified service trades or businesses subject to income phase-outs.7Office of the Law Revision Counsel. 26 USC 199A – Qualified Business Income For 2026, the deduction begins phasing out at $201,750 of taxable income for single filers ($403,500 for married filing jointly) and disappears entirely at $276,750 single ($553,500 joint). If your income clears those ceilings, you get no 199A benefit at all, which changes the math when comparing structures.
Reasonable Compensation and Audit Risk
The employment-tax gap between salary and distributions creates an obvious temptation: pay yourself almost nothing in salary and take everything as a distribution. The IRS knows, and reasonable compensation is the single most-audited issue for S-corp owner-employees.
There is no formula in the tax code. Courts weigh factors including your training and experience, the duties you perform, hours you devote, what comparable businesses pay for similar work, and the corporation’s dividend history.8Internal Revenue Service. Wage Compensation for S Corporation Officers Tax Court decisions have been consistent: an employer cannot avoid employment taxes by relabeling an officer’s wages as distributions. Dividends taken by an accountant who performed all the company’s services have been reclassified as wages. Even “loans” from the corporation to its sole shareholder have been treated as wages for payroll tax purposes.6Internal Revenue Service. S Corporation Employees, Shareholders and Corporate Officers When distributions are reclassified, you owe the back payroll taxes plus penalties and interest.
The workable approach is to pay yourself a salary that reflects what you would earn doing the same job for someone else, then take remaining profit as a distribution. The Social Security wage base for 2026 is $184,500, above which the 6.2 percent Social Security tax (12.4 percent combined) stops on further salary.9Social Security Administration. Contribution and Benefit Base The 2.9 percent combined Medicare tax has no cap.
Your Ongoing Filing and Payroll Obligations
A C corporation files Form 1120 and pays tax at the corporate level.10Internal Revenue Service. Instructions for Form 1120 (2025) An S corporation files Form 1120-S, which is informational. Either way, you also file your personal Form 1040 reporting your W-2 wages and, if S-corp, your Schedule K-1 pass-through income.
Corporate estimated tax payments are required if the corporation expects to owe $500 or more for the year. Calendar-year corporations pay on the 15th of April, June, September, and December.11Internal Revenue Service. Publication 509 (2026), Tax Calendars Missed or short payments produce an underpayment penalty tied to the shortfall, how long it stayed unpaid, and the IRS’s quarterly interest rate.12Internal Revenue Service. Underpayment of Estimated Tax by Corporations Penalty
The corporation also has to run payroll for your salary. That means withholding federal income tax, Social Security, and Medicare from each paycheck, paying the employer’s matching share, and filing Form 941 quarterly. It is predictable work for a one-person company, but the deadlines are real, and late deposits carry their own penalties.
Retirement and Health Insurance
Retirement contributions are one of the strongest reasons to incorporate. A Solo 401(k) lets you contribute as both employee and employer. For 2026, the employee elective deferral limit is $24,500, with an $8,000 catch-up at age 50 and up and a higher $11,250 catch-up for ages 60 through 63.13Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500 On the employer side, the corporation can contribute up to 25 percent of your W-2 compensation as a profit-sharing contribution. Combined employee and employer contributions cap at $72,000 for 2026, or $80,000 with the standard catch-up, $83,250 with the age 60–63 catch-up.14Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs The employer contribution is deductible to the corporation.
Health insurance is treated differently depending on your election. An S-corp owner holding more than 2 percent of the stock (any solo owner) must have health insurance premiums the corporation pays included in W-2 wages. You then claim an above-the-line deduction on your personal return, which reduces adjusted gross income. This treatment requires the plan to be established by the S corporation and only applies if you are not eligible for coverage through a spouse’s subsidized employer plan.15Internal Revenue Service. S Corporation Compensation and Medical Insurance Issues For a C corporation, premiums the corporation pays are deductible as a business expense and are not added to the owner’s wages. Simpler, but rarely enough on its own to justify staying a C corp.
Corporate Formalities That Keep the Veil Intact
A one-person corporation still has to look and act like a corporation. You wear every hat: sole shareholder, sole director, and every required officer position (president, secretary, treasurer). Most states allow one person to hold all of them at once. When you sign a contract or open an account, sign as an officer of the corporation, not in your personal capacity. That distinction is what binds the corporation rather than you.
Several formalities are not optional:
- Adopt corporate bylaws when you form the entity. They do not have to be long, but they should cover how decisions are made, how officers are appointed, and how shares are handled.
- Document annual meetings of the board and shareholders, even when you are the only person present. A one-page resolution recording officer elections, salary approvals, and major decisions is enough.
- Keep a separate corporate bank account. All revenue goes in, all business expenses come out, and personal spending never touches it. Commingling is the fastest way to lose liability protection.
- File your state’s annual or biennial report. Fees typically run between $10 and $150. Missing the filing can result in administrative dissolution of your corporation.
One requirement you can set aside: as of March 2025, the interim final rule under the Corporate Transparency Act exempts all domestic entities from filing beneficial ownership information reports with FinCEN. The reporting requirement now applies only to foreign companies registered to do business in the United States.16FinCEN.gov. Beneficial Ownership Information Reporting
When Courts Pierce the Veil
Liability protection is not automatic. When a court decides the corporation is only your alter ego, it pierces the veil and your personal assets become reachable for the corporation’s debts and judgments. Courts weigh the totality of how the corporation is run, and certain patterns come up over and over:
- Commingling funds, whether by running personal expenses through the corporate account or depositing corporate revenue into a personal account.
- Ignoring formalities, meaning no bylaws, no meeting minutes, no documented corporate decisions.
- Undercapitalization, forming the corporation with negligible assets and no realistic ability to cover foreseeable liabilities.
- Failing to deal at arm’s length in transactions between yourself and the corporation.
- Using the entity as a shell that routes money without any real business function beyond shielding you from obligations.
For a solo owner, commingling and skipped formalities are where cases are usually lost. When only one person is involved, the line between “me” and “my company” is easy to blur, and blurring it is exactly what courts look for. Keeping a corporate account, recording annual minutes, and signing as an officer rather than personally are the habits that protect everything the corporation was set up to protect.