Is Barter Better? Maybe Not...

At some point in most business owners' career, the idea of swapping goods or services comes up. It seems to have a beautiful simplicity about it. If you have someone do some computer work for you in exchange for designing their business cards, you're not out any cash and he doesn't have to report any income. Right?

Not so fast. The IRS is on to that one. It's known as "barter", defined by the IRS as "an exchange of one taxpayer's property or services for another taxpayer's property or services". And, reading further on the IRS website, "The fair market value of property or services received through barter is taxable income."

Yes, in our example, both you and your computer guy will need to report on your tax returns the fair market value of the services each receives. The same would apply if goods changed hands. Furthermore, each of you would have to issue a 1099-MISC to the other if the value over the course of the year was $600 or more. You can also each write off the amount as a business expense. So it seems like a wash and who cares in that case? But if one of you is not providing something for business use, then only one side of the transaction has a tax impact. If I do my friend Ann's taxes in exchange for a year's supply of her excellent tea, I don't get to write off the tea (unless it is going in my office's break room for the use of the employees--but it isn't). She and I still both have to report the fair market value of the tea and the tax prep as income. I do not have to issue Ann a 1099-MISC because I was not using the tea for business purposes. That does not, however, meant that Ann is not required to report the value of that tea as income. The IRS isn't too concerned if you write it off as an expense but they definitely care that you report the income!

If you join an actual bartering exchange, it gets even more fun as you will get your transactions reported by the exchange on a 1099-B. In this case the 1099-B replaces the need to issue a 1099-MISC for all transactions that go through the exchange.

The barter rules apply to your employees, too. If your employee works a little extra in exchange for free football tickets, that's a taxable event. You need to increase his wages on his paycheck even though he didn't receive any cash, and withhold taxes on that amount (and pay your share of the employment taxes too). In addition, overtime rules could apply.

Any exchange that would normally be taxable, whether business-related or not, is subject to the barter rules. Check out the IRS Bartering Tax Center for all the details.

You may ask, how is the IRS going to know about your bartering activity? Without a 1099, they probably won't. But you didn't hear that here. I'm just telling you what's required.