The 1099 check inside every IRS audit: what the examiner must verify about your information returns before the case can close

What a required filing check is

Every SB/SE field examination and every LB&I examination includes a set of required filing checks. The manual states the purpose in one sentence: "Examiners should determine that taxpayers are in compliance with all federal tax and information return filing requirements ... and that all returns reflect the substantially correct tax" (IRM 4.10.5.1, Aug. 28, 2025). The returns in scope are "the taxpayer's returns, all related returns that impact the taxpayer's returns and any return the taxpayer is responsible for filing or can control," and the list of what must be verified names "Information returns (e.g., Form 1099, Form 926, Form 1095-B, etc.)" alongside employment, gift, excise and pension returns (IRM 4.10.5.2.1, June 1, 2010).

The check answers two questions: "Has the taxpayer under audit filed all required returns?" and "Do any of the returns controlled by the taxpayer warrant audit?" (IRM 4.10.5.2, June 13, 2017). The second matters as much as the first. A 1099 problem found during an income tax audit can become an employment tax audit, a backup withholding case, or an information report on a contractor, each with its own file.

The manual also draws a line the examiner must respect. "The inspection of a return is not an examination," and "No records should be examined as part of this process." The examiner may ask why a number changed, but "should not request records to verify or substantiate items on the return being inspected as this may constitute an examination" (IRM 4.10.5.2). That distinction decides whether a prior or subsequent year has been opened, and it is worth knowing when the questions start.

The path the examiner follows

The documentation is not optional. SB/SE field examiners "must use the mandatory administrative Lead Sheet 200, Multi-Year and Related Returns," and the file must show "Actions taken to verify that all required returns (e.g., prior and subsequent, related, information, etc.) were filed including the internal sources of information (e.g., IMFOLI/BMFOLI, etc.) reviewed for each return" (IRM 4.10.5.2.4, Mar. 25, 2022). If the examiner concludes there is no filing requirement, "this must be documented in the case file" (IRM 4.10.5.2.6, Aug. 23, 2019). An examiner who skips the 1099 question has a gap on a mandatory lead sheet, which is why the question is asked in audits that have nothing to do with contractors.

What the examiner reads before asking you

"To decrease taxpayer burden, examiners should use internal sources of information" first (IRM 4.10.5.2.1). For information returns the named tool is the payer master file: "Research filed information returns using command code PMFOL" (IRM 4.10.5.6.1, June 13, 2017). For employment tax the list is specific (IRM 4.10.5.5.1, June 1, 2010):

What that research shows about you is described on what the IRS sees about you on PMFOL. The manual warns the examiner that the transcript will not tie to the return: "some payments made to the payees may be under the threshold amounts for reporting, or fragmented between several deductions on the tax return, or amounts may differ due to cash versus accrual, or fiscal year versus calendar year deductions" (IRM 4.10.5.6.1). That is the gap the examiner's questions are meant to close, and it is the gap your own reconciliation should close first.

Examiners are also told where the 1099 lead comes from in the case file: "A Payor Master File (PMF) indicator, '1099 Filer,' will appear on Form 5546, Examination Return Charge-Out Sheet, if the taxpayer is listed on the PMF. The case file may include a PMF transcript" (IRM 4.10.5.6, June 1, 2010). A business that has never filed a 1099 arrives at the examiner's desk without that indicator, which is its own signal.

The return lines that point to a 1099

The manual tells the examiner to "Determine the potential filing requirements for information returns," pointing to Publication 1220's list of reportable payments, and adds that "Certain line items of the income tax return are often indicative of an information return filing requirement" (IRM 4.10.5.6.1). It then lists the forms a business is most often required to file: 1099-A, 1099-B, 1099-C, 1099-DIV, 1099-G, 1099-INT, 1099-K, 1099-MISC, 1099-NEC, 1099-Q, 1099-R and 1099-S. The examiner's three minimum steps after the research are to "Question the taxpayer regarding their internal procedures for information reporting," to "Verify all reporting requirements have been met," and, "For incomplete and nonfiled Forms 1099, consider the applicability of backup withholding."

The question about internal procedures is the one to prepare for. The useful answer is a description of the process: how vendors are set up, when the W-9 is collected, how the name/TIN pair is checked, which general ledger accounts feed the 1099 run, and how the year-end reconciliation to the return is done. "We use software" is not a procedure.

Prior and subsequent years

"Examiners must ascertain that all information returns required to be filed by the taxpayer are filed for all open periods. Generally that includes the prior and all subsequent periods, as well as the period under audit" (IRM 4.10.5.6.1). Required filing checks cover "All subsequent year returns that are filed or due before the audit is closed from the group" and "All prior year returns that have open statutes, including those not filed" (IRM 4.10.5.3, June 13, 2017). A subsequent year's 1099s that come due during a long audit are therefore inside the check, and the examiner is reminded that if a case returns to the group, compliance with "any new filing requirements" must be confirmed again before it closes.

There is a shortcut, and it rewards a clean audit year: "If the taxpayer complied with the 1099 filing requirements in the year under audit, and review of the prior and subsequent income tax returns does not identify additional expense items requiring issuance of a Form 1099, an in-depth analysis to determine potential filing requirements is not necessary for the prior and subsequent years" (IRM 4.10.5.6.1).

When 1099s are missing: penalty, then backup withholding

Three things follow a missing or incorrect 1099, in this order.

The returns are secured. "If examiners find that a return within the taxpayer's sphere of influence has not been filed, they should solicit the delinquent return, except when fraud or willful failure to file is indicated" (IRM 4.10.5.2.6). The procedure for securing delinquent information returns and sending them for processing is IRM 20.1.7.5.1, the same one that governs late 1099s filed during an examination.

The penalty is considered. "Examiners are required to consider the penalties during an audit if it is found that the taxpayer failed to file, filed late, or filed incorrectly. The resulting improvement in voluntary compliance (payer or payee) will justify the expenditure of time required to pursue the penalties and/or to secure copies of the incorrect or delinquent information returns" (IRM 4.10.5.6.2, June 1, 2010). The penalties are IRC 6721, 6722 and 6723, with reasonable cause under IRC 6724; they "are not subject to notice of deficiency procedures" and go to Centralized Case Processing for assessment. The penalty arrives as the same information return penalty a filer gets from the campus, with the same reasonable-cause defense, but proposed by an examiner who has already read your procedures.

Backup withholding is weighed. The manual restates IRC 3406 and then: "When Form 1099 has not been filed by the taxpayer for a properly classified independent contractor, examiners should consider whether a condition requiring backup withholding exists along with the Form 1099 penalty case" (IRM 4.10.5.6.3, June 13, 2017). The condition is usually the first one on the list, "The payee fails to furnish a TIN to the payer in the manner required." A payer that never collected a W-9 and never withheld owes the tax it should have withheld, which is the subject of the backup withholding examination and the Form 4669 relief that can reduce it.

That alternative position is the reason an unsubstantiated "outside labor" deduction is a worse problem than it looks. The examiner has two ways to resolve it: disallow the expense, or accept the expense and treat the payee as a contractor who gave no TIN. The second produces an assessment of 24% of the payments plus the 1099 penalty, and it is available precisely because the payer cannot say who was paid.

The worker classification line the examiner must not cross

Before backup withholding is raised, "the examiner must first determine whether or not a worker is an employee ... If the worker is an employee, backup withholding is not applicable and if asserted, could establish a safe haven" (IRM 4.10.5.6.3). The safe haven is section 530, and the manual is careful about it: "If an employment tax audit is not initiated, the examiner should refrain from asking questions regarding the classification of a worker. These questions suggest that the examiner is conducting an audit on worker classification and could establish a safe haven available under section 530" (IRM 4.10.5.5.3, June 13, 2017). General questions about contract labor are allowed; once they "lead the examiner to believe a worker has been misclassified, then an employment tax audit should be initiated before asking additional questions," and Publication 1976 "must be provided to the taxpayer before initiating any worker classification examination."

For a payer this is a useful marker. Questions about why a contractor was engaged and what the work was are part of the 1099 check. Questions about control, hours, tools and exclusivity mean a worker classification examination has begun, with the section 530 and CSP rules that go with it.

The employment tax check sheet

Exhibit 4.10.5-1 is a pro forma check sheet the examiner can use to decide whether an employment tax issue exists. The first three questions are answered yes or no about compliance; the rest describe payment patterns. If any of questions 1 to 3 is "NO" or any of 4 to 13 is "YES," "an employment tax issue may be present and the examiner should gather additional information to determine if an audit is warranted."

The sheet skips from 13 to 15 in the published exhibit. Question 5 is the one that reaches most businesses: a line for outside labor, commissions or subcontractors on the return is, by the manual's own design, enough to open the employment tax inquiry, and the answer the examiner wants is a 1099 run that ties to that line.

Your contractors as spin-off cases

The check runs in both directions. Examiners "should be alert to nonfiled related ... and spin-off returns (e.g., relatives, employees, employers, subcontractors, return preparers/ representatives, etc.)," and specifically: "If the taxpayer has employees and/or subcontractors (e.g., return preparer, lawyer, etc.), determine if required information returns have been filed (e.g., Form W-2 or Form 1099) and if not, verify whether the employees and/or subcontractors have filed" (IRM 4.10.5.2.6). When a 1099 was not filed, the examiner looks the payee up.

What happens next needs a manager: "Managerial approval is required prior to opening an examination on any related or spin-off case." Where an examination of the contractor is warranted but not started, the examiner prepares Form 5346, Examination Information Report, for Planning and Special Programs (IRM 4.10.5.14, Aug. 23, 2019). The payer is not told, and the subcontractor's own compliance never appears in the payer's file. The 1099 you did not file can still start an examination of the person you paid.

Health coverage and foreign information returns

Two further families of information return are on the same check. "Examiners must verify that required health coverage information returns are filed": Forms 1094-B, 1095-B, 1094-C and 1095-C, researched on IRPOL (IRM 4.10.5.13, Aug. 23, 2019). An applicable large employer that did not file is referred on Form 5346 for the information return penalties and the employer shared responsibility payment; the inquiry that follows is described in Letter 5699. And a business with foreign owners, foreign subsidiaries or transfers to foreign entities is checked for Forms 926, 3520, 3520-A, 5471, 5472, 8621, 8858, 8865 and 8938, with a referral for international assistance (IRM 4.10.5.7, June 13, 2017). Forms 1042 and 1042-S are reached through the employment tax side of the check, which lists "Withholding on income paid to foreign persons" among the withholding taxes considered in every business audit (IRM 4.10.5.5, Mar. 25, 2022); that examination is described in the foreign vendor exam as the IRS runs it.

What to do before the audit starts

• Reconcile the 1099 run to the return. Build the bridge the examiner cannot: each expense line that carries reportable payments, the total paid, the amounts under threshold, the corporate payees, the amounts reported. The manual expects the numbers not to tie; the reconciliation is what shows why.
• Write the procedure down. Vendor setup, W-9 timing, TIN verification, the accounts that feed the run, the year-end review. This is the answer to the one question the manual requires the examiner to ask.
• Find the missing W-9s now. Every payee without a TIN is a backup withholding exposure the examiner is told to consider. Solicit before the audit, and keep the solicitation record.
• Check prior and subsequent open years. They are inside the check unless the audit year is clean.
• File what is missing before it is asked for. A late 1099 filed on your own carries the ordinary late penalty; one secured by an examiner carries the same penalty with a weaker reasonable-cause story.
• Know where the classification line is. Answer questions about what the contractor did and why. If the questions turn to control and hours, ask whether a worker classification examination has been opened and whether Publication 1976 is being provided.

Questions people ask