When the IRS examines a nonprofit, school or government as a payer: the TE/GE exam of 1099s and W-2s

What the examiner has before the first meeting

"Starting February 1, 2021, C&CA is responsible for securing most Form W-2 and Form 1099 data for TE/GE examination cases" (IRM 4.70.6.7.1, Feb. 21, 2021). Classification and Case Assignment "will upload CP2100 notice recreates into RCCMS case files during the initial case build" when requested, and "will provide IRPTR data for three tax years during the initial case build of all employment tax cases." The examiner arrives knowing which of your payees the IRS flagged on CP2100s and what you reported for three years.

What the examiner checks

The planning chapter is specific. "Line items of Form 990 are often indicative of an information return filing requirement, e.g., interest paid, subcontractors labor, rents, consultants, legal and accounting fees, advertising, etc." The examiner is told to "Review highest paid contractors at Form 990 at Part VII, or Form 990-EZ at Part VI, or Form 990PF at Part VII," to "Use CFOL command PMFOL to determine if the organization has filed information returns. Use IRPTR to review filed Forms 1099 series," to "Question the organization or government about their internal procedures on information reporting," and to "Review copies of the Form 1099 series" (IRM 4.70.12.3.6.2.2, Nov. 22, 2023). The highest-paid contractor list you put on the 990 is the first place the examiner looks for a missing 1099-NEC.

The certificates are inspected too: "Inspect withholding and other statements retained by a payer organization on the Form W-4, Form W-4P, Form W-9 or Form 5754 series. In the case of organizations or governments with non-resident alien employees or foreign payees, inspect withholding statements on Form 8233, Form W-8BEN, Form W-8ECI, Form W-8EXP or Form W-8IMY" (IRM 4.70.12.3.6.2). A university with visiting scholars or a hospital with foreign locum physicians should expect the W-8 and 8233 file to be read. The compliance-check version of this review, which is not an examination, is described in TE/GE compliance checks and Letter 4204.

Delinquent 1099s and W-2s

"If the Examiner determines that the taxpayer failed to file required Forms 1099, they should secure the delinquent Forms 1099. The Examiner should require the payer to furnish the delinquent returns to payees and file them with the Examiner," or file electronically and give the examiner proof. "The payer should be given a reasonable time, e.g., 30 days" (IRM 4.70.13.9.5.6.1, Nov. 22, 2023). The same section tells the examiner that "High dollar delinquent Forms 1099 should be considered by the Examiner for potential income tax underreporting," with a referral of the payee to SB/SE.

For W-2s, examiners "are expected to secure delinquent Forms W-2 ... prior to closing an exam," while corrected Forms W-2c "are not required to be filed until January 31st of the year following the year the examination is completed but the taxpayer should be encouraged to file them earlier" (IRM 4.70.13.9.5.8). An organization that refuses to file is treated harshly: the examiner considers the intentional disregard penalties, and "The taxpayer's appeal rights are post-assessment; the taxpayer will not be able to appeal the civil penalties until Forms W-2 & W-3 have been filed" (IRM 4.70.13.9.5.8.1.1). If refusal continues after those penalties are assessed, the examiner is told to "recommend consideration of the penalty under IRC 7203," the criminal failure-to-file statute.

How penalties are proposed

Information return penalties are kept out of the examination report. The examiner prepares "an information return penalty case file, which is separate from the examination case file," secures "a written penalty relief request," and proposes the penalty by letter: "Issue Letter 5005, Information Return Penalty Notice (Form W-2). Issue Letter 5005-P, Information Return Penalty Notice (Form 1099)" (IRM 4.70.13.9.5.6.2.1, Nov. 22, 2023). W-2 penalties are proposed at the same time as the employment tax examination; if the examiner granted an extension to file W-2c, "penalties don't become assessable until March 1st of the year following the year you close your examination."

Two procedural points follow from the separate file. "Don't secure an agreement on Form 2504 or Form 4549": signing the exam report does not settle the penalty. And relief leaves a record: "If you grant penalty relief ... Assess the penalty for zero ('0') using Form 8278 ... This creates a trail on IDRS showing the considered penalty, the year of consideration, and the reason we didn't assert it" (IRM 4.70.13.12.5). A future examiner will see that relief was given once. The reasonable-cause standard itself is the same as for any payer; see Treas. Reg. 301.6724-1.

Reclassification cases: two penalty positions

When workers paid on 1099-NEC are reclassified as employees, the penalty package carries both versions: "The first set (pair) of Forms 8278 and 3645 will reflect Form W-2 penalty assessments. The second set ... Form 1099-NEC penalty assessments," labeled "Primary Examiner Position" and "Alternate Examiner Position," with an instruction to "Suspend assessment of information return penalties until the taxpayer's request for appeal period has expired" (IRM 4.70.13.9.5.7, Nov. 22, 2023). "If the organization doesn't request an Appeals conference for the worker reclassification issue, the civil penalty recommendation shown in the penalty package as the 'Primary Examiner Position' will be processed": the W-2 penalties, on the reclassified basis. Not appealing the classification is also a decision about which penalty is assessed. The appeal itself is described in worker classification and backup withholding in Appeals.

In Appeals

TE/GE Appeals officers are told to make sure the penalty is on the books first: "Upon receipt of an IRC 6721 and/or IRC 6722 penalty case, the ATE should verify that the penalties have been assessed. If not assessed, the ATE should prepare Form 8278 ... to immediately assess the penalty" (IRM 8.7.8.4.1, Mar. 23, 2018). For state and local governments the same section adds a classification wrinkle: when reclassified workers are covered by a Section 218 Agreement with the Social Security Administration, section 530 relief is unavailable for the FICA taxes but remains available for income tax withholding, and the examiner verifies coverage with SSA.

Time standards

TE/GE publishes national time frames for its examiners: 45 days "To start a field examination measured from the first contact to the initial appointment," 30 days to start a correspondence examination, 45 days between significant activities in a field exam, "14 days ... To respond to correspondence" and "3 days (business) ... To respond to telephone calls" (IRM 4.70.11.6, Nov. 22, 2023). They are internal standards, not deadlines for you, but they are a fair basis for asking where a case stands.

Questions people ask