What your 1099s tell your state: the IRS data exchange extracts

The 1099-NEC extract: unemployment insurance audits

"The 1099-NEC extract is distributed annually in June" from the IRS information returns master file (IRM 11.4.2.7.1, Sept. 15, 2023). It "was developed in response to a recommendation by the Federal Department of Labor (DOL) Office of Inspector General," and the recipients are state workforce agencies, the unemployment insurance side of state government, not only revenue departments.

The extract is narrow on purpose: "The payment information provided on the extract is limited to box 1 (non-employee compensation) and box 4 (federal income tax withheld) of the Form 1099-NEC." It is sorted by the payee's state, but "The records included in this extract are based on the state code of the payer, in addition to the state code of the payee," and "SWAs use the non-employee compensation information as a component in the audit selection process to increase discovery of unreported income and non-filers." A business that pays a large group of people on 1099-NEC is visible to the state agency that decides whether those people were employees for unemployment insurance purposes, without the state having to ask.

The full information return extract

The broader extract "contains data from the IRMF which is a database containing all transcribed information returns," including "Form 1099, Form 1098, Schedule K-1, Form 5498, Form 8300, Form W-2 and Form W-2 G" (IRM 11.4.2.7.11, Sept. 15, 2023). It goes to state tax agencies by payee state code and to cities by ZIP code, distributed in July. It is slow: "Each file takes approximately 18 months to create, resulting in the data being two years behind the year of distribution." Tax year 2024 data reaches the states in 2026.

The manual lists what states use it for: "Identify underreporters. Identify excess deductions. Identify employers who are withholding but not remitting. Match Schedule K-1 data to state tax agency databases to identify resident and non-resident non-filers." The third is about payers: state withholding shown on your W-2s and 1099s that never reached the state's own deposit records.

Nonresident payees: records go to the payer's state

A second version of the extract reverses the usual direction. "Agencies that enroll for this extract can also select the optional Non-Resident W-2/W-2G/1099-MISC/1099-NEC records," and "records will be included on the Non-Resident K-1 extract by payer state code provided the address of the payer is within the requesting agency's state and the payee's address (non-resident) is outside the requesting agency's state" (IRM 11.4.2.7.11). It is distributed in October.

So a payer in one state that pays contractors living in others is reported, through the IRS, to its own state as well as to the payees' states. This is separate from the Combined Federal/State Filing program, which forwards records to participating states at the payer's election and on a much faster schedule; the data exchange runs whether or not the payer elected anything.

The levy extract: your EIN as a source

States can ask the IRS each month for the payers who reported income to a given delinquent taxpayer. The levy extract "reflects payer and payee data for specific taxpayers from Form 1099-INT, Form 1099-DIV, Form 1099-NEC, Form 1099-K, Form 5498, and Form W-2, as well as Schedule K-1," is run from a state tickler file, and is used to "Locate names of payers of income for levy sources" (IRM 11.4.2.7.12, Dec. 3, 2020). A state levy that arrives naming your business as holding money for a contractor usually traces to the 1099-NEC you filed, the same way federal vendor levies do; vendor levies covers the federal version.

The CP2000 extract

When a payee agrees to, pays, or defaults on a CP2000 proposal built from your 1099, the result is shared. "Only data elements from fully agreed cases processed through AUR that resulted in an additional federal tax assessment are provided on the CP2000 extract" (IRM 11.4.2.7.4, Dec. 3, 2020), and the manual calls it "one of the easiest methods for state departments of revenue to generate correct assessments." Among its stated uses: "Identify employers and payers not reporting to the state tax agency." A payer whose 1099 started a federal CP2000 may hear from the state about the same payment, and about its own state filing of it.

What it means for a payer

• Classification is checked at the state level from your 1099-NEC file. The federal section 530 safe harbor does not bind a state unemployment insurance agency.
• State withholding has to be deposited where you report it. The full extract is used to find "employers who are withholding but not remitting."
• Nonresident payees still surface in your home state. Whether or not you file directly with every payee state.
• Two years is not too late. The full extract runs two years behind, so a state inquiry about a 2024 payment in 2026 is on schedule. Keep W-9s and payment records at least that long; the state filing pages give each state's own requirements.

Questions people ask