Bartering is a process of product or services exchange that has been going on since the 70’s. It became widely popular that the Internal Revenue Service (IRS) aimed to regulate it. Since barter is an exchange of goods and services of equal value without the use of money, this type of industrial transaction entails no tax at all. But laws on taxes change over time so IRS came up with guidelines regarding tax on barter.
In 1979, then IRS Regional Director, Roland Wise stated “Bartering is certainly legal. It is the oldest way of doing business there is. Our concern is that barterers don’t abuse, misuse, or break the law, and there is little doubt that bartering is a little more conducive to that opportunity.”
Some medium size businesses make use of barter to cut on expenses since they can exchange products or services with other “favours” as well. But to put doubts on deemed “tax exceptions” and “legalities” to rest it is better if we get to understand the basic concepts regarding barter taxation.
(Why do you have to consider barter for your business? Click here.)
Favours vs. Barter
The difference IRS puts between barter and gifts is the “intent.” When people do each other favours or give each other gifts, they are not taxed for it. Gifts are things given to some people without anything expected in return, however, people tend to exchange goods for moral reasons BUT as long as these “favours” are not deemed by both parties as a “potential income” or “supposedly sale,” then these are non taxable.
Barter: The “Supposedly Sale or Income”
When people exchange services or products as part of a business or a transaction process, then it is considered bartering.
In any business, each product or service amounts to a certain price. When two parties dealt to exchange services or products to be used in their businesses then they have to consider the “fair market value” of these goods for taxation purposes. For example, An artist agreed to paint a portrait in exchange of free dental service. Simply, how much would the portrait cost if the artist charged for it? How much would the dental service cost if the dentist also charged for it? That is the “fair market value that both the dentist and the artist must declare in IRS released forms.
Fair Market Value
Any service or product exchanged is taxable regardless of the mode of exchnage: either individual or through bartering clubs. What exactly is fair market value? According to IRS it is the price at which the item or comparable item may be sold considering location and may not be “forced sale price” or its price in the market. In short,it could be the retail sales price of the item at the time of the sale.
Providing and Receiving Barter
If you provided barter, the supposed price of that good must be listed in income value and if you received barter, then list the “price” of what you received under “cost of business.”
Cost of business is regarded as “adjusted cost base” of the goods for tax and the “Income value” is considered “proceeds of disposition” used to calculate income or capital gain. “Like-kind Exchanges” are tax deferred not tax free. It means that if like-king products are acquired through bartering it is tax free, but it is taxable when you decide to sell them.
What are “like-kind exchanges?” These are NOT SIMILAR types of products (cars in exchange of cars) but products used for similar reasons.
The price of like kind goods exchanged for the purpose of business should be declared in the forms released by the IRS for taxation purposes, however, these are tax deferred which means that the tax imposed on the goods exchanged are the tax that should be listed as “expenses” to offset some the business’ tax liabilities.
In short, bartering is technically tax free but the price of bartered goods must be declared in IRS forms under proper labels.
Disclaimer: I am not a legal adviser nor trying to provide one. Contact your tax lawyer for in depth explanation.