Have You Seen this in an Audit

[Kram BergGold]

Speaker at a conference yesterday said she has seen the IRS disallow a Schedule C deduction, in an audit, for payments to a sub contractor because the 1099 was not issued. The taxpayer had adequate proof of the payment. When I have faced this situation prior to 2011 the examiner just made my client prepare the 1099 and all was well. Has anyone else heard about anything like this?

[JohnH]

I see lots of posts on forums by accountants and tax preparers who seem to WANT to penalize the client by threatening to refuse to list the tax deduction on the original return if a 1099 isn't/wasn't issued. (Personally, I don't buy into auditing the client myself - I leave that to the IRS). But now that the 1099 questions are on the return, much of this 1099 discussion has gone by the wayside.

But to answer your question, I've never actually run into anyone who verified that this happened in an audit. I fail to see how the IRS could disallow the deduction in this situation, absent any written authority to do so. They might be able to issue a penalty for late filing of the 1099, but that's a different animal altogether. I'd suspect that if a tax preparer let an auditor pull this one over on them, then either the preparer isn't very effective in handling an audit, they're too eager to take the IRS position in order to stay in the auditor's good graces, or there may have been other reasons for not challenging the decision. Other reasons might include unrelated problems on the return which they wish to avoid, using this as a negotiating tactic, or maybe the deduction itself was a little flaky in the first place.

[BOB W]

I had the same, "no deduction until 1099 issued". When the 1099s were issued the deduction was allowed. Some of the 1099s only had name and address.