BARTER SYSTEM AND THE TAX CODE 6/11

The IRS tax code includes numerous sections on the barter issue. They consider bartering a taxable event. In fact, in the instructions and attachment for page one, line 21 "Other Income" is "Bartering Income".

The barter system goes back to the beginning of time for human business dealings. To stay within the tax code, one needs to understand a few rules.

If I trade my services as a tax return preparer, then I show the value of the trade as income to my business. The person who traded with me gets to write off the cost of the trade, the cost of the tax return prep, as an expense. Thus, the trade is for an even amount. The IRS gets my income on my tax form and my client's expense as an entry on his or her tax return.

A trapper owed me $200.00. We traded tanned furs and called it even. In the world of doing favors for each other, the deal is done. But, then the tax code kicks in. I will show that amount as income and he will show that amount as a cost of having his taxes done. But, if he is in the business of trapping and shows his trapping on his tax return, he also has income of $200.00. Thus, I show a net income of $200.00. He shows net income of zero because he has an expense of $200.00 for tax prep and he shows $200.00 as sales of furs.

If a meat farmer trades with me, it is the same. I get $150.00 worth of meat and he gets a $150.00 tax return expense. I show income of $150.00 and he shows income of $150.00 to his farm and expense of $150.00 for my services.

BUT, if he trades labor for meat, then what? He is approached by an unemployed neighbor who says he will work on the farm in exchange for meat. The farmer now has a $15.00 per hour worker. They agreed to the value up front. The end of the week finds the farmer had 20 hours labor provided to him and he gives the worker $300.00 worth of frozen organic beef. Everybody is happy.

The IRS looks at this differently. They say the farmer has income of $300.00 to his farm for meat traded. He also has $300.00 worth of labor costs. The worker has income on page one of form 1040, line 21 "Other Income".

If the farmer does $600.00 or more of trade with this worker in a year, he has to give the worker a 1099 MISC form in January of the next year for the total amount of the trade value incurred in the prior year.

If a dentist trades $500.00, he shows the $500.00 as income and the patient shows $500.00 as a medical expense. If the patient happens to be his cleaning lady, he shows income of $500.00 and her cleaning expense as $500.00. She shows medical expense of $500.00 and cleaning services income of $500.00. A simple trade has four tax applications. Whew!

Treat the trade as though money was exchanged if you have a business. If you only trade occassional babysitting for carrots and lettuce from a neighbor who is not a farmer, there are no tax issues involved. A car mechanic needs to show barter income but your neighbor who is a fix up guy does not need to show the trade value.

I know of a couple who tries to trade for everything. They may have a problem in an audit because the auditor will ask how they paid their bills with no checking account and no taxable income. The IRS will likely determine that they are laborers and the value of all their trades will be taxable as self-employment income subject to federal, state and self-employment tax on net profits. That would be nasty.

If our economy does not improve, more and more barter will occur. The IRS will be right there, hand out and a big smile.