Bartering — exchanging goods or services without using cash — has been a common business practice for generations. Today, businesses can also use online barter exchanges to make trades easier.
Bartering can offer several advantages. It may help preserve cash, provide access to products or services a business needs, reduce excess inventory and introduce a company to new customers or markets.
However, bartering isn’t tax-free. For federal income tax purposes, the IRS generally treats the value of goods or services received through a business barter transaction as taxable income, much as if the business had received cash.
Understanding how barter transactions are taxed can help business owners avoid reporting mistakes and identify legitimate deductions.
How Business Bartering Is Taxed
When you receive goods or services through a business barter transaction, you generally must report their fair market value (FMV) as taxable income.
If two businesses exchange services, both businesses generally have taxable income based on the fair market value of what they receive.
The income should generally be reported in the same manner as comparable income received in cash. For example, a sole proprietor generally reports business barter income on Schedule C. Depending on the circumstances, the income may also be subject to self-employment tax.
The good news is that reporting barter income doesn’t necessarily mean the entire value of the transaction becomes taxable profit. Depending on what you receive and how the transaction is structured, you may be able to claim a business expense deduction or establish a tax basis in property received.
Example: Businesses Exchanging Services
Consider a veterinarian who agrees to provide services to a marketing consultant in exchange for marketing services.
Both businesses generally must report the fair market value of the services they receive as income.
The veterinarian would report the value of the marketing services received, while the marketing consultant would report the value of the veterinary services received.
The fair market value will generally be the amount that would ordinarily be charged for the services. If both parties agree on a value before completing the transaction, that amount generally can be used as the FMV unless there is evidence showing that it isn’t appropriate.
Bartering Doesn’t Eliminate Business Deductions
A barter transaction can create taxable income while also generating deductible business expenses.
For example, suppose a plumber repairs or installs a toilet at a computer repair shop in exchange for having a business laptop repaired.
The plumber generally must report the fair market value of the computer repair services received as business income.
However, the plumber may also be able to deduct qualifying expenses associated with the transaction. If the laptop is used in the plumber’s business and the repair would have qualified as a deductible business expense if it had been paid for with cash, the plumber generally may still claim the deduction, subject to the normal tax rules.
The plumber may also be able to deduct qualifying costs related to the plumbing work, such as materials, supplies and eligible employee wages.
Exchanging Services for Property
Bartering isn’t limited to service-for-service transactions.
A business can also exchange services for property, inventory or other assets. The value of what is received generally must be reported as income.
For example, suppose an HVAC contractor performs work for a retail business in exchange for unsold inventory. The contractor generally must report income equal to the fair market value of the inventory received.
Similarly, if an architect provides services to a corporation in exchange for shares of stock, the architect generally must report income based on the fair market value of the shares received.
These transactions can also create additional tax considerations, including the basis of property received and the tax consequences when that property is later sold.
How Barter Exchanges Work
Some businesses participate in online barter exchanges, sometimes called barter clubs. These organizations facilitate trades among members.
Instead of directly exchanging services with another business, members may receive credit units for goods or services they provide. Those credits can then be used to obtain goods or services from other members.
The tax rules can be different from a simple direct trade because income may arise when the credits are added to the member’s account.
When Barter Exchange Credits Become Taxable
In general, barter income is taxable in the year the transaction occurs. When you participate in a barter exchange, however, you may be required to recognize income when credits are credited to your account, even if you don’t use those credits until a later year.
For example, suppose a business earns 2,500 barter credits and each credit can be exchanged for $3 worth of goods or services.
The business would generally have $7,500 of income for that year.
If the business uses those credits the following year, it generally wouldn’t recognize another $7,500 of income simply because it redeemed the credits, because the income was already recognized when the credits were earned.
Keeping accurate records of when credits are earned and redeemed is therefore important.
Tax Forms and Barter Exchange Reporting
Businesses participating in barter exchanges generally must provide identifying information to the exchange. This may include a Social Security number or Employer Identification Number (EIN), along with a completed Form W-9 or similar certification.
In certain circumstances, including situations where a taxpayer identification number isn’t provided or properly certified, barter income may be subject to 24% backup withholding.
Barter exchanges are generally treated as brokers for information-reporting purposes. When applicable reporting requirements are met, the exchange may issue participants Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, generally by February 15 of the following calendar year.
The form can report the value of cash, property, services and credits received through the barter exchange during the preceding year. The information is also reported to the IRS.
Keep Detailed Records of Barter Transactions
Because no cash changes hands in a barter transaction, it can be easy to overlook the tax consequences.
Businesses should maintain records showing:
- What goods or services were exchanged
- The date of the transaction
- The fair market value of what was received
- How the FMV was determined
- Any related business expenses
- Barter exchange credits earned or redeemed
- Forms 1099-B and other tax documents received
Good documentation can make it easier to accurately report barter income and substantiate deductions if questions arise.
Bartering May Be Useful, But It Isn’t Tax-Free
Bartering can be a practical way for businesses to conserve cash, obtain needed services, use excess inventory and develop new business relationships. But a transaction doesn’t become tax-free simply because no money changes hands.
Whether you trade directly with another business or use an online barter exchange, you generally need to consider the fair market value of what you receive and report the appropriate income.
Federal and state tax rules can also differ, so businesses should consider the tax consequences before entering into significant barter arrangements.
We can help you determine the fair market value of goods and services exchanged, identify potentially deductible expenses and maintain the records necessary to properly report your barter transactions. Contact us to learn more.
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