In today’s economy, small-business owners sometimes look to the oldest form of commerce — the exchange of goods and services, or bartering. The Internal Revenue Service wants to remind small-business owners that bartering transactions generally have associated tax reporting, accounting and record-keeping responsibilities.
Bartering is the trading of one product or service for another. Usually there is no swap of cash. Barter may take place on an informal direct one-on-one basis between businesses and individuals, suppliers, customers, distributors, partners, contract labor, and employees, or it can take place on a third party basis through a modern Internet barter exchange. Bartering is an exchange of one taxpayer’s property or services for another taxpayer’s property or services. The fair market value of property or services received through barter is taxable income.
Once you have agreed to barter transactions with a vendor or customer, you must enter the transaction accurately in your accounting and tax records. Whether you maintain your books and records manually or use one of the many accounting and tax software packages on the market today, you need to keep and record some basic information about your barter transactions.
Clearly mark or file all barter income and expense documents as “bartering,” and retain all original source documents pertaining to your barter transactions such as Sales receipts and invoices as well as Barter exchange statements and Forms 1099-B, Proceeds From Broker and Barter Exchange Transactions
Bartering Products or Services
The most important barter tax accounting concept is that the IRS treats bartering as income received, whether you use accrual-basis or cash-basis accounting.
Direct Barter Transactions – If you engage in the direct barter of products or services with an individual or a business you will generally not receive a Form 1099-B, but the transaction must be accounted for in your books and records just the same. Think of a barter transaction as just another sales transaction of your business goods or services you must include in your income at the time received. Accurate accounting and record keeping can help you manage barter transactions.
For example, if a doctor agrees to give an accountant a personal medical exam in exchange for personal tax return preparation, the fair market value of the medical exam is taxable to the accountant, and the fair market value of the tax return preparation is taxable to the doctor.
For simplicity sake, let’s assume the fair market value of both services is equal to say, $200. Note that all pieces of the transaction should be clearly marked as a bartering transaction in the books and records of both the doctor and the accountant. With the fair market value of both services being equal, both the doctor and the accountant must include $200 in their income as a result of the bartering transaction.
Barter Exchange Transactions
Exchanges occurring through a barter exchange are reported to IRS on Form 1099-B and show the value of cash, property, services, credits or scrip added to your account by the barter exchange. Record keeping and accounting for barter exchange transactions is basically the same as for direct barter transactions except that you are taxed on the value of the credit units added to your account even though you may not actually receive goods or services from other exchange members until a later year. You will have additional help in determining the taxable bartering amount by information reporting from the barter exchange.
Barter exchanges record all transactions and report them to the IRS on Forms 1099-B. The value of trade dollars received for your products or services must be included in gross income for the tax year in which they are credited to your account. If your business is a corporation, you will receive one aggregate Form 1099-B annually.
If you are a partnership, individual or a sole proprietor, you will receive a Form 1099-B from the exchange for each barter transaction with a value of $1 or more.
Bartering as Compensation
Barter can be used as compensation, too. A business can pay bartered goods or services as a bonus or as part of a compensation package to employees, partners and contractors. For example, a business may use barter bonus or sales incentive programs, with compensation including such items as vehicles, restaurant certificates or resort trips.
Just as cash business expenses associated with bartering are deductible, barter used as compensation is deductible and subject to employment taxes and information reporting. Barter used as a bonus or compensation for an independent contractor must be included on the contractor’s Form 1099-MISC, Miscellaneous Income, as non-employee compensation, and all barter compensation for employees must be taken into account on their Forms W-2. Barter compensation is subject to FICA, FUTA, and federal income tax withholding.
Other Examples of Bartering Transactions
Small businesses and self-employed taxpayers greatly benefit by accurately recording and reporting all income. Insufficient record keeping could cause income to be over-reported and too much tax paid or too little income reported and too little tax paid. You need good records to prepare your tax returns. These records must support the income and expenses you report.
You are a self-employed financial planner who performs services for a client, a small business corporation. The corporation gives you shares of its stock as payment for your services. You must include the fair market value of the shares of stock in your income on Schedule C or Schedule C-EZ of Form 1040. The expenses you pay in the performance of the financial planning services are also deductible.
You own a small apartment building. An artist trades you a painting in return for six months’ rent-free use of an apartment. You must report the fair market value of the artwork as rental income on Schedule E Supplemental Income and Loss on Form 1040. Generally, this would be the fair rental value of the apartment for six months. You can claim your normal rental expenses associated with the barter of the apartment. The artist must report the fair rental value of the apartment in income on Schedule C, Profit or Loss From Business (Sole Proprietorship), or Schedule C-EZ, Net Profit from Business, of Form 1040 as the artist would for any other sale of a painting. The artist can claim the normal cash business expenses associated with the bartered work of art such as canvas, paint, brushes, supplies and materials.
You are a self-employed house painter. In return for painting his personal residence, your attorney agrees to perform personal legal services. If you would normally paint such a residence for $3,000 you would report the $3,000 in your gross receipts and you would be able to deduct the ordinary and necessary business expenses associated with painting the residence (such as paint, brushes and equipment rentals) on Schedule C or Schedule C-EZ of Form 1040. The attorney must also report the fair market value of the services in gross income on Schedule C or Schedule C-EZ of Form 1040, and deduct his ordinary and necessary business expenses associated with the legal services.
You are a self-employed owner of an online retail Web site that sells bowling shirts, shoes, balls and supplies. In return for fully equipping a self-employed owner of an online retail fishing shop with bowling equipment with a fair market value of $1,000, you receive fishing rods and clothing also valued at $1,000. You must include the fair market value of the equipment you receive in your income on Schedule C or Schedule C-EZ of Form 1040. You will also increase your cost of goods sold by decreasing your inventory for the cost or other basis of the bowling equipment given up. The fishing shop owner will handle record keeping the same way if both maintain inventories. Both you and the fishing shop owner will report the income of $1,000.
Be sure to use a reasonable fair market value for the property or services received in a barter transaction to include in your income. The transaction is not a “wash” if you report the fair market value of the property received that is greater than your cost or basis in the property given up. In Example 4, if the bowling equipment given up has a cost or other basis of $500 to you there is a $500 gross profit on the transaction since the fair market value of the fishing equipment received is $1,000. Simply put, you should identify the transaction in your records and report the income and any related business deductions and cost of goods sold on Schedule C or Schedule C-EZ of Form 1040.