How the IRS uses information returns and why that matters

The IRS receives millions of W-2 and 1099 filings each year directly from employers, banks, and payers. These forms create a near-complete ledger of payments made to taxpayers that the IRS can automatically compare to what taxpayers report on their returns. When the numbers don’t line up, the IRS’s systems flag the return for review and may send a notice proposing an adjustment.

This matching process matters because it drives most of the IRS’s non-criminal enforcement work: it finds underreported income, corrects withholding errors, and uncovers missing information that affects refunds and tax liabilities. The system is not perfect, but for most straightforward cases the automated match is accurate and fast.

(For official background, see the IRS information return pages: About Form 1099 and About Form W-2.)

Sources: IRS — About Form 1099 (https://www.irs.gov/forms-pubs/about-form-1099); IRS — About Form W-2 (https://www.irs.gov/forms-pubs/about-form-w-2).

What information returns the IRS sees (common forms)

  • W-2 — Wage and tax statement from employers (wages, federal/state withholding, Social Security and Medicare wages).
  • 1099-NEC — Nonemployee compensation for contractors and freelancers (commonly used for payments of $600 or more by a payer).
  • 1099-MISC — Rents, prizes, and other miscellaneous payments.
  • 1099-INT / 1099-DIV — Interest and dividend income from banks and brokers.
  • 1099-B — Broker proceeds and sales of securities (including many crypto broker reports).
  • 1099-K — Payment card and third-party network transactions reported by payment processors and marketplaces.

Each form feeds into the IRS’s information reporting databases that power automated comparisons to the amounts reported on Form 1040, Schedule C, Schedule D, and other return lines.

Useful related guides on FinHelp: Guide to 1099 Forms: Reporting Gig and Contract Income and W-2 vs 1099: Which Income Goes Where?.

How the matching system typically works (step-by-step)

  1. Payer files information return and furnishes a copy to you.
  2. The payer transmits the same data to the IRS (electronically in most cases).
  3. You file your tax return reporting wages, interest, business receipts, etc.
  4. The IRS runs automated matching programs comparing the payer-reported amounts to the taxpayer-reported amounts.
  5. If amounts match, the return moves through regular processing.
  6. If there’s a mismatch, the IRS may: delay processing, generate an automated notice (for example, CP2000-type proposals), or select the return for further review.

The matching engine is very fast for common items (wages, interest, contractor earnings) and slower for complex items like cost basis on investments or some types of partnership allocations.

Common reasons returns are flagged

  • You omitted income from a 1099 or W-2.
  • The payer reported income to the wrong TIN or spelled your name differently.
  • The payer sent a corrected information return after you filed (for example, a W-2c or corrected 1099).
  • You reported net profit/loss differently (for example, a Schedule C that doesn’t reconcile with multiple 1099-NEC forms).
  • Matching errors on broker reports or marketplace transactions where basis or character of income differs.

When a payer makes an error (wrong amount or wrong SSN/EIN), the correct fix is for the payer to file a corrected return. If you receive a notice first, you can still respond with documentation and the payer’s corrected form if available.

What happens if the IRS finds a mismatch (common notices and steps to respond)

Typical first step: the IRS sends a notice that explains the proposed change and shows the information return amounts it has on file. The most common form of outreach is a CP2000-like notice proposing additional tax because income appears underreported.

Your immediate steps should be:

  1. Read the notice carefully — identify which form and amount triggered the change.
  2. Compare the IRS’s figures with your copies of the W-2s and 1099s and your bank, ledger, or accounting records.
  3. If the IRS is correct, sign and return the response form or pay the proposed amount (or request a payment plan).
  4. If you disagree, gather documentation: pay stubs, invoices, receipts, contracts, corrected information returns (W-2c/1099-c) and a clear written explanation.
  5. Follow the notice instructions and include documentation. If you need more time, the notice usually gives a deadline and instructions for requesting more time or appealing later.

Responding promptly reduces interest and penalty exposure and often preserves appeal rights.

Practical examples from practice

  • Example A: A freelancer received three 1099-NEC forms totaling $45,000 but only reported $40,000 on Schedule C. The IRS matched the 1099s, flagged the return, and issued a proposed adjustment. After reviewing bank deposits and invoices, the taxpayer amended the return to report the missing $5,000 and paid tax plus interest. Early reconciliation of invoices would have prevented the notice.

  • Example B: An employee’s employer transposed the Social Security number, so W-2 wages were reported under a different SSN. The IRS flagged the return for mismatch. The employer issued a corrected W-2 (W-2c) and the taxpayer supplied the corrected form; the IRS then adjusted its records without penalty because the taxpayer acted promptly.

These real-world scenarios show that most problems can be fixed when taxpayers keep good records and respond quickly.

Tips to avoid matches that trigger notices

  • Keep an organized folder (digital or paper) for every W-2, 1099, and brokerage statement you receive each tax year.
  • Reconcile 1099s to your bank deposits, invoices, and accounting records before filing.
  • If you expect seasonal or third-party payments, ask payers for a W-9 so they have your correct name and TIN on file (see our guide: Understanding Form W-9, W-2, and 1099).
  • Review payee TINs and request corrected information from payers when you see errors.
  • If you receive a corrected return after filing, consider filing an amended return (Form 1040-X) if the corrected amount affects your tax liability.

Penalties and timing to know

  • If you simply underreport income and the IRS closes the case with an adjustment, you will typically owe additional tax plus interest. Accuracy-related penalties can apply in some cases.
  • Statute of limitations: the IRS generally has three years from the date you file to assess additional tax; exceptions apply for substantial understatement, fraud, or if you don’t file at all.
  • Employers and payers can face penalties for late or incorrect information returns.

See the IRS pages about information returns and specific forms for up-to-date filing rules (IRS — Information Returns).

When to get professional help

Contact a tax professional if:

  • The proposed adjustment is large or you believe it’s incorrect.
  • You receive an audit notice, or the IRS asks for detailed business records.
  • You suspect identity theft (someone else’s income reported under your SSN) — this requires immediate action and an Identity Protection PIN may be necessary.

In my practice I’ve found that organized recordkeeping and prompt communication with payers cut resolution time and reduced penalties. If you’re unsure how to respond to a notice, a CPA, EA, or tax attorney can help you draft a clear reply and represent you before the IRS.

Final checklist if you get an IRS mismatch notice

  • Don’t ignore the notice. Read and calendar the reply deadline.
  • Gather copies of the payer’s information return and your supporting records.
  • Ask the payer for a corrected return if the payer made the error.
  • If you agree, pay or arrange payment to reduce interest and penalties.
  • If you disagree, respond with documentation and request an appeal if needed.

Disclaimer

This article is educational and does not constitute tax advice. For guidance specific to your situation, consult a qualified tax professional. Official IRS resources are linked above and should be consulted for current filing instructions and legal requirements.

Authoritative sources

Internal FinHelp links referenced