Will the IRS Catch a Missing 1099?
Discover how IRS systems cross-reference financial data to find unreported income, even without a 1099, and the correct way to ensure your return is accurate.
Many freelancers and independent contractors wonder about the consequences of not reporting Form 1099 income. The Internal Revenue Service (IRS) has sophisticated, automated systems to identify unreported earnings. While not every instance is immediately flagged, the IRS’s detection capabilities are extensive, creating a significant likelihood of discovery.
The IRS Automated Underreporter Program
The most direct way the IRS identifies unreported income is through its Automated Underreporter (AUR) program. This system cross-references information returns, like Form 1099-NEC, with the income reported on an individual’s Form 1040 tax return. When a business issues a Form 1099, it must also file a copy with the IRS, creating a data trail linked to the recipient’s Taxpayer Identification Number (TIN).
The AUR system electronically scans information returns and compares them against taxpayer-reported income. If the system finds a mismatch, such as a Form 1099-NEC for $15,000 that does not appear on the recipient’s tax return, it flags the return for review. A tax examiner may then analyze the case before a notice is sent.
This matching process is effective because it relies on direct, third-party reporting. The system looks for a specific data point present in IRS records but absent from the taxpayer’s return. This automated comparison is the foundation of the IRS’s ability to detect unreported 1099 income and is responsible for identifying millions of mismatches annually.
Detection Without a Payer-Filed 1099
The IRS has several methods for detecting unreported income even when a payer fails to issue a Form 1099. These alternative methods provide the agency with multiple avenues to uncover income that was not reported on a tax return.
- Form 1099-K Data: Third-party settlement organizations and payment card processors issue Form 1099-K to report payments for goods and services. This gives the IRS another stream of income data to compare against tax returns.
- Bank Deposit Analysis: During an audit, agents may scrutinize a taxpayer’s bank records. A pattern of large or regular deposits that don’t match reported income can trigger a deeper investigation into the source of the funds.
- Audits of Other Taxpayers: An audit of a business might uncover payments made to a contractor for which a Form 1099 was never issued. This provides direct evidence of income paid to the contractor.
- Public Records: The IRS can use public information, such as business licenses or professional registrations, that suggests an individual is earning income.
Potential IRS Actions Upon Discovery
Once the IRS identifies unreported income, it initiates contact by sending a CP2000 notice. This notice is not a formal audit but a proposal to adjust the taxpayer’s income based on information the IRS received from third parties. The CP2000 details the income the IRS believes was omitted, identifies the payer, and shows a calculation of the proposed additional tax.
If a taxpayer owes more tax, the financial consequences include the back taxes owed on the unreported income. This amount is subject to interest, which accrues from the original due date of the tax return and compounds daily until the balance is paid.
In addition to interest, the IRS can assess an accuracy-related penalty of 20% of the underpayment of tax resulting from negligence. The IRS may also impose a failure-to-pay penalty of 0.5% of the unpaid taxes for each month they remain unpaid, up to a maximum of 25%. These penalties are added to the tax and interest, increasing the total amount due.
Amending a Return to Report Income
If you discover unreported income before the IRS contacts you, you can correct the error by filing Form 1040-X, Amended U.S. Individual Income Tax Return. Filing an amended return can help minimize penalties and interest. You will need a copy of your original tax return to complete the form.
On Form 1040-X, you must enter the figures from the original return, the net change for each adjusted line item, and the corrected amounts. You must also provide a detailed explanation for the changes, such as reporting additional self-employment income from a specific payer.
Any new forms affected by the change must be attached. For instance, unreported self-employment income requires attaching a completed Schedule C and Schedule SE. Payment for any additional tax owed should be submitted with the amended return to stop further interest and penalties from accruing.