Introduction: Electroencephalography (EEG) is increasingly used to investigate brain responses to transcranial magnetic stimulation (TMS). A relevant issue is that TMS is associated with considerable auditory and somatosensory stimulation, causing peripherally evoked potentials (PEPs) in the EEG, which contaminate the direct cortical responses to TMS (TEPs). All previous attempts to control for PEPs suffer from significant limitations. Objective/Hypothesis: To design an optimized sham procedure to control all sensory input generated by subthreshold real TMS targeting the hand area of the primary motor cortex (M1), enabling reliable separation of TEPs from PEPs. Methods: In 23 healthy (16 female) subjects, we recorded EEG activity evoked by an optimized sham TMS condition which masks and matches auditory and somatosensory co-stimulation during the real TMS condition: auditory control was achieved by noise masking and by using a second TMS coil that was placed on top of the real TMS coil and produced a calibrated sound pressure level. Somatosensory control was obtained by electric stimulation (ES) of the scalp with intensities sufficient to saturate somatosensory input. ES was applied in both the sham and real TMS conditions. Perception of auditory and somatosensory inputs in the sham and real TMS conditions were compared by psychophysical testing. Transcranially evoked EEG signal changes were identified by subtraction of EEG activity in the sham condition from EEG activity in the real TMS condition. Results: Perception of auditory and somatosensory inputs in the sham vs. real TMS conditions was comparable. Both sham and real TMS evoked a series of similar EEG signal deflections and induced broadband power increase in oscillatory activity. Notably, the present procedure revealed EEG potentials and a transient increase in beta band power at the site of stimulation that were only present in the real TMS condition. Discussion: The results validate the effectiveness of our optimized sham approach. Despite the presence of typical responses attributable to sensory input, the procedure provided evidence for direct cortical activation by subthreshold TMS of M1. The findings are relevant for future TMS-EEG experiments that aim at measuring regional brain target engagement controlled by an optimized sham procedure.