Ask the Tax Czarina: Bartering

Last week, SFWA’s own “Tax Czarina” discussed some basic tax issues writers face. This week’s Q&A focuses on bartering.

Q: What’s the big deal about barter income?

A: Someone, somewhere, has decided that Americans are bartering for goods and services and not including the transactions on their tax returns. The government has spent a lot of tax dollars trying to estimate the size of what they call the ‘tax gap.’ An online article in Time states a range from $385 billion to $600 billion, depending on the study, and also an estimate that 84% of that number is under-reported income, some of which is from barter transactions.

Not reporting barter income, like not reporting tips or cash transactions, is income tax evasion. Tax evasion is illegal. Tax evasion should not be confused with tax avoidance, which is paying the lowest possible tax, utilizing all legal deductions. Tax avoidance is your right as a taxpaying citizen, to paraphrase Judge Learned Hand.

Businesses have been engaging in barter on organized barter exchanges for several decades now. And, as you might guess, the IRS has a form for that. There, on Form 1099-B, the form you receive for stock transactions, at the very bottom, in box 13, is Bartering. But that’s when the income is from a formal bartering exchange.

When a barter transaction is more casual, it might be reported on Form 1099-MISC if the payment was made in the course of a business and is more than $600. The example the IRS gives is a painter paints an attorney’s office in exchange for representing her in a divorce case at a value greater than $600. The attorney must give the painter a Form 1099-MISC with the value of his legal services in Box 7, but the painter does not owe a 1099-MISC to the attorney because the legal work is not related to his painting business.

But wait, didn’t I say US citizens must report all their income in an earlier question? Yes, I did. So even though a 1099-MISC wasn’t issued to the attorney, he must still report the income for his services from the painter, just as the painter must report the income on the 1099-MISC the attorney gave her. The difference is the attorney has an offsetting business deduction for having his offices painted and the painter does not because a divorce is considered personal.

To sum up, here are some real world examples. My client provides editing and mentoring services for writers. I prepare and sign her tax return, which includes her writing business. I will have bartered tax return preparation income and a deduction for her editing services. My client has bartered editing income and a deduction for her tax return being prepared. While tax return preparation usually goes on Schedule A as an itemized deduction, it may be deducted directly against a business, if that’s the reason my client has her tax return prepared and signed by a paid preparer. The transaction offsets for both of us, it’s a wash. Assuming the amount is under $600, neither of us issues the other a Form 1099-MISC.

One of my clients makes glass art as a small business. She brings her current inventory with her to show me when we go over her tax return. I pick out a piece of jewelry, a glass pendant, for my daughter in partial payment for my client’s tax return. My client writes up a sales slip, properly charging me sales tax (ouch!) and deducts that total from the invoice I just handed her, writing me a check for the difference. She has income from the bartered sale of the pendant and takes a deduction for the cost of making it. She will also take a deduction for my invoice, since, like my other client, she has it professionally prepared because of her small business. I have income for the full amount of my invoice. And now, I have just realized that I do not have an offsetting expense because the pendant is a gift for my daughter, which makes it a personal purchase. In fact, I now owe my corporation the difference between the invoice and her check. I end up recognizing all of the income from the transaction, just as if she had paid me in full with a check. I think my client came out slightly better in this transaction, at least financially. I, on the other hand, have a daughter who loves the pendant her mother just gave her.

In summary, barter transactions are reportable. Transactions that wash are less of an issue than transactions that don’t. The above examples demonstrate that bartering might or might not result in net taxable income for either or both parties. Sometimes it’s clear how the transaction should be treated and sometimes it’s not. If you’re unclear how your side should be reported, you should consult a professional tax advisor, who may or may not agree to barter for their services.

•••

ozThe Tax Czarina is a licensed CPA with more than 25 years of experience preparing US Federal and state tax returns. After earning a Masters of Accountancy degree, her resume includes working for the now-defunct largest accounting firm in the world, for the world’s largest cement and construction material firm, and for her own one-woman company, which specializes in individual and small business income tax. She is currently the preparer for SFWA’s tax filings. She is not looking to add new clients.

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3 Responses

  1. Jeff Weaver

    CAUTION: The examples you give are all incorrect. The fair market value of the goods/service received is the reportable income. The cash cost of the goods/services you provide is the expense.

    In general, barter swap transactions are never a wash. Uncle Sam has a hard time accepting that one’s profit is a tax deductible expense. The expense is the actual cash cost of providing a service, which general automatically appear as deductions already in the form of COGS or other expense categories.

    From: https://www.irs.gov/taxtopics/tc420.html

    “You must include in gross income in the year of receipt the fair market value of goods or services received from bartering.”

    1. Tax Czarina

      Dear Jeff:

      I see that you work for an organized barter exchange. If you have some comments to offer on how someone like a writer might use an exchange to their benefit, that would be most welcome. It’s fascinating that there are ways for corporations (is it only corporations?) to exchange services and goods on an organized exchange.

      I think, however, that you’re jumping the gun a bit stating that all 3 examples provided are incorrect. For one thing, I’m not discussing the reporting for transactions on an organized exchange, but the informal ones.

      Example #1, the attorney and the painter, is from the 2016 instructions for Box 7 of Form 1099-MISC. https://www.irs.gov/instructions/i1099msc/ar02.html#d0e911. It’s a direct quote of an example given (other than changing gender) and then I have provided the clarification that both sides still report the income, whether or not a 1099-MISC was issued.

      Example #2 is the rare ‘wash’ situation you cited. In this situation, the tax preparer records income for the full fair value of the tax return. The editor records income for the full fair value of the editing/mentoring services provided. The wash occurs when the tax preparer is also in the business of writing and takes a deduction for the services provided by the editor to edit one of their stories, an ordinary and necessary business expense. It also occurs because the editor deducts the cost of tax preparation as an ordinary and necessary business expense. This example was chosen as a variation of another example given in the Form 1099-MISC instructions where the attorney’s services are not personal, but are for bad debts, an ordinary and necessary business expense for the painter. I felt that the editor/tax preparer example was more relevant to the audience of this blog than the painter/attorney example, especially as the editor/tax preparer example is more purely service for service, as if the tax preparer and the editor had exchanged checks in the same amount. It’s a trade of services, as noted in the link you provided above. In this particular situation, both sides of the transaction are business transactions for both parties and that results in the rare wash event.

      Example #3 is more the kind of example you’re talking about. The artist records the full fair market value of the sale of her pendant, including appropriate sales tax, and takes a deduction for her cost of goods sold, as you said. The tax preparer records the full payment for the tax return, both the cash and the sales price of the pendant, and has no offsetting expense deduction elsewhere. Example #3 does not result in a wash transaction.

      In all three examples given, all taxpayers have included in gross income in the year of receipt the fair market value of goods or services received from bartering, without exception.

      Yrs,
      Tax Czarina