Question: We are just completing an IRS audit.  Taxpayer did not file 1099s for all independent contractors.  The IRS has informed us that they will disallow the expense for those recipients.  Does anyone know under what authority they can do this?

Answer: You won't find any authority for it, because there isn't any. There is no authority in the IRC for IRS auditors to disallow the deduction if a 1099 is not filed. The only remedy that they have is a penalty (It's gone up recently, I think it's $250 per unfiled form, last time I checked). So if you're talking about dozens or even hundreds of unfiled forms, you could potentially have a problem either way.

It's usually an empty threat. If there's anything that the IRS is good at, it's playing chicken.

On the California side, though, there is authority for the disallowance based on unfiled 1099 forms, but it is currently being litigated.

In my opinion, this is a ridiculous issue-- businesses should not be required to play such a large role in compliance. These are reporting forms, and it's an administrative burden that I don't agree with, on so many levels. That being said, we always encourage our clients to file 1099 forms.

As recently as last year, we had an IRS auditor scream "You are required to do this! This is YOUR job!" (with regards to 1099 filings), and we responded that although we offer the service, nobody in our office works for free. So, look at the situation. You can go to appeals, or agree to concede. It's usually just a numbers game. If your client is going to have a small adjustment, or has other issues that might come up once the file is moved to appeals, then you might want to consider a concession. Otherwise, this is a safe issue to fight, because the IRS has no authority to disallow the deduction.

 
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