Does your business barter? Here are some facts you should know
In today’s economy, many small businesses are strapped for cash. They may find it beneficial to barter or trade for goods and services instead of paying cash for them. The problem with bartering is it is taxable income to each side at retail price, or fair market value, and may be a poor tax choice. Bartering is the oldest form of trade and the internet has made it easier to engage with other businesses. But if your business gets involved in bartering, be aware that the fair market value of goods that you receive in bartering is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.
How it works
Here are some examples:
- A computer consultant agrees to exchange services with an advertising agency.
- A plumber does repair work for a dentist in exchange for dental services.
In these cases, both parties are taxed on the fair market value of the services received. This is the amount they would normally charge for the same services. If the parties agree to the value of the services in advance, that will be considered the fair market value unless there’s contrary evidence.
In addition, if services are exchanged for property, income is realized. For example,
- If a construction firm does work for a retail business in exchange for unsold inventory, it will have income equal to the fair market value of the inventory.
- If an architectural firm does work for a corporation in exchange for shares of the corporation’s stock, it will have income equal to the fair market value of the stock.
Barter clubs – Not a good choice for many businesses
Many businesses join barter clubs that facilitate barter exchanges. These clubs generally use a system of “credit units,” which are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.
In general, bartering is taxable in the year it occurs. But if you participate in a barter club, you may be taxed on the value of credit units at the time they’re added to your account, even if you don’t redeem them for actual goods and services until a later year. For example, let’s say that you earn 2,500 credit units one year, and that each unit is redeemable for $2 in goods and services. In that year, you’ll have $5,000 of income. This means you not only gave goods to the barter club to earn the credits but you also have to pay income tax on it even though all you received were barter club credits! You won’t pay additional tax if you redeem the units the next year, since you’ve already been taxed once on that income.
If you join a barter club, you’ll be asked to provide your Social Security number or Employer Identification Number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club is required to withhold tax from your bartering income at a 24% rate.
Reporting to the IRS
By January 31 of each year, a barter club will send participants a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services and credits that you received from exchanges during the previous year. This information will also be reported to the IRS.
Conserve cash, reap benefits
By bartering, you can trade away excess inventory or provide services during slow times, all while hanging onto your cash, but you may end up paying unnecessary income tax sooner than you might otherwise, You may also find yourself bartering when a customer doesn’t have the money on hand to complete a transaction. As long as you’re aware of the federal and state tax consequences, these transactions can benefit all parties. Also, US Income Tax Returns require listing if you are involved in bartering transactions. That is always a hot topic in tax audits! If you need assistance or would like more information, contact me at 856-665-2121..