The IRS view of bartering: Fine, but declare it
There is nothing new under the sun. Today, the concept of barter is back in a big way.
On the internet, online bartering companies provide a trading environment for businesses and individuals. There are web-barter.com and Barterfest.com, as well as sophisticated trading sites like recipco.com, and wintagio.com -- just a few examples out of many. You can trade services for products, or services for services, and so on.
Since it is difficult to get an exact match where two businesses need equal amounts of each other's products or services, the opportunities for direct barter transactions are limited. That's where a barter exchange network comes in.
The network deals in units of currency called trade dollars. The goods and services of one company in the network are exchanged for trade dollars that can be used to purchase the goods and services of any other company in the network.
The network functions as a record keeper, sending each client a monthly statement and charging a fee usually 5 percent to 7 percent for each side of a transaction.
Do I have to pay tax on my bartering income?
Yes. You have bartering income when you exchange goods or services without exchanging money, or the full amount of money. The goods or services exchanged have a dollar or fair market value, and this value must be included on the tax return of both parties as bartering income.
The IRS considers barter exchange networks to be legal third-party record keepers, similar to banks, brokerage houses and other firms that deal with taxpayer records.
Barter exchange networks are required to complete and submit Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, for each of their members and the IRS.
Example: Let's assume you are a house painter and you paint a dentist's house. The dentist pays you $5,000 for the work. You have $5,000 of income. Then you go to the dentist and get implants for which you pay him $5,000. He has $5,000 of income.
If you just trade the work (you paint his house in exchange for the dental implants) you get the same result. You each have $5,000 of taxable income. The fact that the cash did not pass back and forth does not mean there is no taxable income.
The fair market value of the goods and services exchanged, $5,000 in our example, must be included as income for both parties. Generally, barter income is reported on Schedule C, Profit or Loss from Business Form 1040.
Barter accounting tips.
There are a few accounting guidelines to remember when you conduct barter transactions.
First, all barter income is dealt with on a cash basis. The IRS treats barter as income received whether you use accrual-basis or cash-basis accounting. You must report and pay taxes on barter income for the year in which it accrues.
If your business is profitable, you should try not to have unspent barter credits at the end of the fiscal year. What should you do if you have unspent barter credits at the end of the fiscal year? You may be able to contribute unspent barter credits to charity and deduct them from your taxes.
Using barter as compensation.
Barter can be a great way to provide bonuses or other types of compensation without putting a strain on cash flow. You can provide compensation by awarding restaurant certificates or trips to resorts.
Barter compensation, like cash, is subject to personal taxes. If you use barter to compensate a contractor, include it on his or her Form 1099; if the recipient is a regular employee, declare it on his or her W-2 and withhold all appropriate taxes.
What does the IRS think about barter?
Some business people believe the IRS takes a dim view of barter transactions. As a result, they may assume that using barter subjects them to possible audits or to other legal scrutiny.
The truth is that a company using barter is no more likely to get audited than any other business. IRS rules concerning barter are well established. It is understood that barter is a perfectly legitimate business transaction.
Between 1979 and 1983, the IRS ran a project to examine the barter business. During that time, barter exchange networks were audited, along with a sample of their clients returns. The study disclosed that businesses that used barter had a better than average record of tax compliance.
Today, a company that barters has the same chance of being audited as any other organization.
Treat barter just as you would any other business activity. Keep good records, work with a reputable barter exchange network and consult a qualified CPA if you have any questions or problems.