In today’s economy and the ever-evolving digital world, exchanging goods and services with another business or individual, known as bartering, is common practice. In fact, the International Reciprocal Trade Association (IRTA) estimates the annual volume of barter transactions to be between 12 and 14 billion dollars. Clearly, bartering is a viable and, oftentimes, advantageous transaction for companies. Therefore, it is important to understand what bartering means in the present day and how it affects your tax planning. Bartering income is taxable income.
What makes up the barter economy?
IRTA lists the four major sectors of the barter and trade economy as:
- Traditional retail barter exchange companies – also known as mutual peer-to-peer credit clearing systems
- Corporate barter companies – companies who perform larger corporate barter transactions
- Countertrade – typically occurs between sovereign governments; focus is on import and export of commodities
- Complementary currency systems – local/community-based currencies
IRTA estimates that the international barter economy is 50% countertrade, 30% corporate barter and 20% retail barter. Furthermore, IRTA believes the central component driving the barter industry in the last 35 years is the shift from one-to-one trading to third-party trading. In turn, this has resulted in the development of sophisticated internet-based software to maximize trading opportunities while simultaneously offering quality accounting and reporting functionality.
How does the IRS come into play?
Most governments outside of the United States have recognized the economic benefits of increased commerce that barter systems provide. As such, many of these governments have followed the U.S.’s lead and model, accepting barter transactions as a feasible alternative form of commerce. Therefore, barter transactions are a taxable event.
Also note that the IRS is not the only U.S. taxing authority to recognize bartering dollars as “real dollars.” In fact, many states impose a sales tax, as well as an income tax, on barter transactions.
Income Tax and Self-Employment Tax
Barter dollars are the fair market value of the goods and/or services you receive in a barter transaction. This fair market value amount is taxed as if it is cash. Therefore, you may owe an income tax, self-employment tax, employment tax or even an excise tax on the bartering income. As such, the IRS expects you to report it on Form 1040, Schedule C, Profit or Loss of Business, or other business returns such as Forms 1065, 1120 or 1120-S. In the event that the income is not related to your trade or business, you should report the income as “Other Income” on your Form 1040.
Capital Gains and Losses
If you are exchanging products or tangible assets rather than services, bartering can generate more than income tax. In fact, exchanges of property can result in a capital gain or loss or a nondeductible personal loss. If you barter business assets or close your business, you may have capital gains, ordinary gains and depreciation recapture to report. Furthermore, if your barter property has a fair market value greater than your cost, you will usually have a reportable gain. The status of the gain – capital or ordinary – depends on the length of time you held the property.
Completing bartering transactions can also result in additional reporting specifications. For example, if you issue a Form 1099 to report cash payments for goods or services, then you are required to complete a Form 1099 to report bartering income.
Individuals and businesses participating in a formal barter exchange organization must fill out a Form 1099-B. However, those who do not have a contract with a barter club but do trade services do not file a Form 1099-B. These non-club transactions are reported on a Form 1099-MISC. Click here for more information directly from the IRS.
The IRS does have some barter reporting exemptions. They are as follows:
- Transactions under $1 in value
- Transactions with certain “exempt foreign persons”
- Under 100 transactions per year
What is a barter exchange?
A barter exchange, also frequently known as a barter club, is a third-party organization that facilitates bartering transactions between members. It also functions as a bank to track the value of the transactions and each member’s account. Typically, these groups are regional or local. They have websites where members’ goods and services are listed for sale.
Some businesses recognize barter exchanges as extremely beneficial. Rather than a simple one-to-one transaction, a barter club allows for round-robin type exchanges. For example, your accounting firm may barter with a restaurant who barters with a printing service and so on. Furthermore, the club tracks the transactions for you.
Please take note of some more formal operational components of the barter exchange system. For example, if you sign up for a barter club, you must provide your Social Security number or employer identification number. Additionally, you are asked to certify that you are not subject to backup withholding. The club withholds tax from your bartering income at 24% unless you complete this certification process.
Clubs charge an initiation fee, a transaction percentage, and a monthly maintenance fee. Furthermore, some barter exchanges require an additional monthly fee to “stock” your account in order to encourage buying and selling.
How do barter exchanges affect your taxes?
Barter exchanges are capable of completing two significant tax operations:
1. Record Keeping
If you utilize a barter exchange, it serves as a bookkeeper for your barter transactions. Exchanges have their own trade dollars to collect and track money for businesses that do not have an immediate need to spend it. For instance, if someone barters for your accounting services, you can bank the barter dollars you receive. At a later date, you can spend those dollars to purchase the goods or services you need.
2. Tax Reporting
Your barter exchange provides you with a record of the fair market value of all income you acquired through barter transactions. This information is presented on a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions” by January 31 of each year. The form demonstrates the value of the cash, property, services, and credits received from transactions throughout the prior year. This information is then reported to the IRS.
However, please note that you need to track your expenses related to bartering in order to use them in your business tax return. Expenses offset barter income received.
What are the advantages of bartering transactions?
One of the most beneficial aspects of bartering is the principle of maximizing and utilizing your unused capacity. Through bartering, you can trade away excess inventory that is otherwise wasted. Comparably, you can offer services during slower periods in order to preserve your cash. Both are extremely advantageous for small businesses.
On the other hand, bartering is advantageous when working with a client or customer who does not have access to money to complete the transaction. Rather than losing the customer, you are able to work out a transaction to overcome a lack of necessary cash.
Another benefit is the access to goods and services that you would not necessarily have otherwise. Barter club members are gaining access to hundreds, or even thousands, of products and services locally and nationally. With over 500 barter clubs operating in North America alone, you have plenty of options to find the right exchange for you.
Are there any disadvantages?
Bartering offers a number of positive solutions for your company. However, as with any business strategy, you must consider the possible drawbacks.
Barter exchanges can be a very viable and advantageous forum for your business. However, it is relatively easy to launch a barter club, thus resulting in a considerable number of options for you to choose from. Joining an ill-managed exchange may actually create a liability that negatively impacts your profit margins or budget. Furthermore, you must be aware of price gouging, bait and switch tactics, and other unsavory business practices that may take place within the barter exchange.
To prevent registering with the “wrong” barter club, read honest reviews and research the policies it uses to regulate professional conduct.
If you have any questions about bartering and how it could be useful to you and your business, please contact us today.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.