What happens if an S Corp pays a shareholder via 1099 instead of W-2?

This is incorrect for shareholder-employees. Payments for services must be on a W-2 with payroll taxes withheld. Misclassification as a 1099 contractor can trigger IRS penalties.
Now, that said, if It is after the year has ended, you could use the 1099 and make it subject to self-employment taxes. The rationale behind this is it puts the IRS from a tax perspective in basically the same tax position as it would have been if the taxpayer had done it properly. We have found where this is combined with the taxpayer actually fixing this so its correct going forward and most auditors tend to go along and leave it alone (meaning they don\’t reopen the year and force the taxpayer to file the 941s, 940, W-2 and W-3, creating a lot of penalties and interest).