Tax Considerations for Small Businesses: To Barter or Not to Barter
Barters and trades of goods and services represent an increasingly significant percentage of our economy, especially among small businesses, many of which have turns to one of the oldest forms of commerce in hopes of weathering the recession. One obvious reason is that bartering allows an individual to exchange goods or services for something you that they need, but can’t pay for. But it also allows them to get rid of extra inventory or take advantage of “down time” in exchange for reducing their cash outlay for business expenses. In this economy, bartering is a smart move.
However, as the IRS has warned recently, bartering is still considered business and is therefore taxable activity:
“The fair market value of property or services received through barter is taxable income. Bartering is the trading of one product or service for another. Usually there is no exchange of cash. However, the fair market value of the goods and services exchanged must be reported as income by both parties.”
This rule covers a variety of “transactions” that many, including savvy business owners, might not think twice about: the local barber trading a haircut for a free meal at a friend’s mom and pop restaurant; an artist offering up a painting in exchange for a month’s worth of dog walking? Again, this exchange is considered generated reportable income – for both parties in the barter transaction.
In an effort to help those who fall into this category, the IRS has highlighted the following four facts about bartering that small business owners understand come tax time:
According to the IRS, a barter exchange functions primarily as “the organizer of a marketplace where members buy and sell products and services among themselves.” Applying equally to products produced and sold from a physical space or through the Web, this exchange is bound to the rules governing Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, meaning it must be submitted annually to a barter’s clients or members as well as to the IRS.
In an effort to eliminate any confusion over what is meant by barter income for tax purposes, the IRS has stated, “barter dollars or trade dollars are identical to real dollars for tax reporting.” In other words, the income from this activity should be recorded in the same manner as other forms of income — on the appropriate tax return for the barter’s particular type of business. Generally, this number should correlate to the fair market value of the product or service. A good rule of thumb: It’s the price that a “willing buyer” would pay for the goods or services from a “willing seller.” In other words, what would the cost of that piece of art be on the open market? How much would you normally charge to do cut someone’s hair? Those answers determine the fair market value of the transaction.
Another given is that the bartering income is taxable in the year that it was actually performed. The IRS is also careful to point out that bartering may yield certain liabilities for income tax, self-employment tax, employment tax, or excise tax. A small business that barters barter may incur ordinary business income, capital gains or capital losses, or you may have a nondeductible personal loss.
The reporting requirements for transactions that fall within the category of bartering can hinge on what kind of bartering activity has taken place. Generally, this type of business income on Form 1040, Schedule C Profit or Loss from Business, or other business returns such as Form 1065 for Partnerships, Form 1120 for Corporations, or Form 1120-S for Small Corporations.
The bottom line is that, whether or not tangible money changes hands, a small businesses that barter must treat this activity as they would any other business transaction. That means they must also maintain good records of all bartering transaction — both what is bartered away and what is received.
When to Consult a Tax Professional
Businesses that regularly barter should consider consulting a CPA, IRS enrolled agent or other registered tax agent to learn more about the tax requirements, especially when they are uncertain about reporting requirements or how to best value their services. CPAs and enrolled agents can often help small businesses barter in ways that are beneficial from a taxation point of view, and that are also likely to help them avoid audits from the IRS. Because of their increasing popularity, topics such bartering are routinely covered in tax continuing education courses that tax professional are required to take on an ongoing basis. These tax CPE courses are designed to give tax professionals the latest information on how to best to help taxpayers barter in accordance with IRS rules.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.