Tax Matters

Bartered  is also taxable

By David Katzman

Do you barter? This non-cash form of exchange can be particularly useful for start-up businesses or organizations with cash flow issues or other reasons for conserving cash while still obtaining needed goods and services.

The sometimes unexpected expense, however, is taxes. The Internal Revenue Service (IRS) expects you to treat bartered goods and services just as you would cash transactions. Here’s an example:

Let’s assume you operate a public relations agency and you agree, in a barter agreement, to provide media relations services for your lawyer in exchange for the handling of a legal matter you’ve encountered. In this case, both your company and the law firm must report this activity as income, at its fair market value. How do you determine fair market value?

If both parties agree on an amount, this is considered the fair market value, as long as the amount is within the range of average costs for these services. If you agree to an amount well below the expected range, the IRS could question the legitimacy of the transaction.

If your barter arrangement involves accepting property, rather than services, the fair market value of the transaction is equal to the value of the property accepted. For example, if your public relations firm agrees to do work for a publicly held corporation in exchange for stock, the income you would report would be equal to the value of the stock you received.

Barter exchanges can create extra taxes during some years

With the increased prevalence of barter exchanges, largely because of the growth of the Internet, the tax consequences of these arrangements can become more significant.

Generally, barter groups work on a credit-unit value, which greatly expands the usefulness of bartering because it allows for more flexibility. For example, let’s assume that your public relations company agrees to provide services to a law firm. However, this year your company does not need legal services. If you belong to a barter exchange, you can simply use your credit units to obtain other goods and services you do need.

While this increases flexibility, it can cause some unexpected tax consequences.

When you barter through one of these groups, the IRS expects you to calculate your barter income based on the established value for each credit unit and pay taxes during the year you are issued the credits. For example, if your exchange values each credit unit at one dollar and you accrue 5,000 units, the IRS will expect you to pay taxes on a barter income totaling $5,000. Taxes are due during the year in which you “made” this income, even if you have not used the credits. Since you have already paid taxes, however, you can use your accrued credits during future years with no further tax consequences.

How does the IRS know how much barter income you received?

If you participate in a barter exchange, you will be asked to provide your Social Security number or your employer identification number, and to certify that you are not subject to backup withholding. The exchange will withhold income tax at a rate of 28 percent, if you are subject to backup withholding. Otherwise, no taxes will be withheld, but you will generally receive Form 1099-B at the beginning of the following year. This form indicates the value of income you received from the barter exchange, and the information is simultaneously reported to the IRS. When you receive this form, you include the reported amount as part of your income, just as you would any other income, when you complete your federal tax returns.