The IRS Considers Goods and Services Exchanged Through Bartering To Be Taxable Income to Both Parties
Reviewed by Lea D. Uradu
Not all transactions involve money. Sometimes, individuals or companies exchange goods or services instead. This activity is commonly known as a barter transaction.
If you’re involved in barter transactions, here is what you need to know about how and where to account for them for tax purposes.
Key Takeaways
- Bartering is the exchange of goods and services between individuals and businesses rather than an exchange of money.
- Bartering has become particularly popular online and is often conducted through barter exchanges or clubs.
- The Internal Revenue Service considers goods and services exchanged through bartering to be taxable income to both parties.
- It has rules on how parties to these barter transactions must account for them.
Reporting Barter Revenue
Businesses
Under Internal Revenue Service (IRS) rules, business owners and companies engaged in bartering are supposed to account for the fair market value of all the goods and services they receive or provide through it.
In its annual “Tax Guide for Small Business” publication, the IRS demonstrates where bartering rules may come into play. For instance:
“You are an artist and create a work of art to compensate your landlord for the rent-free use of your apartment. You must include the fair rental value of the apartment in your gross receipts. Your landlord must include the fair market value of the work of art in their rental income.”
In addition, the IRS notes, “Just like payments made with money, if a business makes payments of bartered services to another business (except a corporation) of $600 or more in the course of the year, these payments are to be reported on Form 1099-MISC.”
For bookkeeping purposes, in a standard journal entry, a barter exchange account is treated as an asset account, and the bartering revenues are treated as income items. For example, if the fair market value of a good or service is $100, the barter exchange account would be debited $100 and barter revenues would be credited $100.
Individuals
In the case of individuals engaged in barter transactions, barter revenue must be accounted for, in dollars, on their IRS Form 1040, Schedule C: Profit or Loss From Business. In some cases, it could also be reported on Schedule E: Supplemental Income and Loss.
Note
Bartering is an ancient practice but gained new popularity (and greater IRS scrutiny) with the advent of the internet, which made it much easier for individuals and businesses to conduct barter transactions.
Example of a Barter Transaction
A common example of a barter transaction today involves two internet companies that exchange ad space on each other’s websites. If company A trades $100 worth of ad space in exchange for ad space of like value on company B’s website, both would have to count that as income on their books.
Bartering vs. Trading Services
The IRS differentiates between a trade of similar services between two similar parties on a non-commercial basis and the act of trading saleable business goods or services as described in the example above.
For example, two neighbors who trade off the task of babysitting their children aren’t going to have to report that as income on their tax returns. However, when a plumber provides plumbing services to a dentist in return for dental work, that is considered bartering for tax purposes and both parties could owe income tax on the value of the services they received.
What Is a Barter Exchange?
A barter exchange is sometimes referred to as a barter club. According to the IRS, it’s an organization whose members exchange property or services with each other. A small business owner might, for example, trade goods or services directly with another member or in exchange for credits that they can use at a future date with a different member. Such credits are considered income for the year they are received, even if the recipient doesn’t use them until later.
The barter exchange must supply each member with an annual Form 1099-B: Proceeds From Broker and Barter Transactions showing what they received during the past year. It also must give this information to the IRS.
Are Bartering Transactions Subject to Tax Withholding?
In general, barter transactions are not subject to income tax withholding. However, if you participate in a barter exchange or club and fail to provide it with your tax identification number (TIN) (or provide an incorrect one), you may be subject to backup withholding of 28%.
Do States Also Tax Barter Transactions as Income?
Yes, many U.S. states tax barter transactions as income and may also impose sales taxes on them. According to the accounting firm Wolter Kluwer, states in increasing need of revenue are narrowing their focus on bartering and unreported transactions.
What Is Fair Market Value for Bartering Purposes?
The fair market value (FMV) of a good or service isn’t always easy to determine but is typically based on what that good or service would normally sell for or has historically sold for. The IRS offers a number of similar definitions in its various publications, including this one in its rules for valuing donated property: “It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.”
In the specific case of bartering, the IRS adds that, “If you exchange services with another person and you both have agreed ahead of time on the value of the services, that value will be accepted as the fair market value unless the value can be shown to be otherwise.”
The Bottom Line
While no money may change hands in barter transactions, value does. The IRS views the exchange of bartered goods and services as a form of income and expects it to be reported as such.
For that reason, it’s important for individuals and businesses engaged in bartering to keep good records and to pay particular attention to the fair market value of whatever product or service they provide or receive.
Read the original article on Investopedia.