Actually had this situation come up with the IRS a couple years ago. IRS required that we amend to report the sublease on Schedule E. The IRS was alerted to the situation as the subletting business correctly filed a 1099misc to lessee (unincorporated business). Lessee had reported the expense as a reduction in rent expense. Maybe the difference was the 1099misc reporting, otherwise how would IRS know about it? Either way, we didn't argue, just amended and reported on Schedule E as IRS requested.
