When people think of reporting to the IRS, they generally think in terms of situations where money changes hands between parties, such as an employment relationship or the purchase of a new home. However, trading items or bartering services can also lead to IRS tax liability. If you fail to disclose these types of transactions on your returns, you could open yourself up to severe civil and even criminal penalties. The best thing you can do if you are unsure whether or not something needs to be reported is to contact an experienced tax attorney like those at the Tax Law Offices of David W. Klasing before filing your returns. We can work to ensure everything is accurately and wholly reported and save you the hassle of a potential audit down the line. Read below to find out if trade is taxable by the IRS even if no money changed hands.
For the IRS, “barter dollars,” the fair market value of the goods and services you received, are treated precisely the same as cash payments. As such, if bartering is part of the ordinary course of business, you could owe business taxes on each trade you make. Furthermore, if you would have had to pay self-employment taxes on the fair market value of the services, if they had been paid in cash, you will have to pay those taxes in a bartering situation as well.
For example, say you are a hairdresser who routinely trades haircuts for other services such as having your house cleaned, having your landscaping done, and having a cake baked. Because this is a part of your business, the IRS expects you to report the fair market value of each service received as taxable income on Form 1040, Schedule C, or other business returns such as Form 1065 for partnerships, Form 1120 for corporations, or Form 1120-S for small business corporations. The cleaner, landscaper, and baker will, in turn, have to report the fair market value of your hairdressing services as taxable income on their returns, and pay self-employment taxes if they apply.
If you trade a service that is not a part of your normal course of business, then you will report that income on your 1040 as “Other Income.” For example, if you are not a professional hairdresser but just cut this one individual’s hair in exchange for their landscaping services, you will need to report the fair market value of the landscaping services as “Other Income.” The landscape will still need to report the fair market value of the haircut as a business expense, however, as an IRS tax liability.
There are also additional IRS reporting requirements associated with bartering. If you would have to issue a 1099 form to report cash payments for goods or services, you must also do it for goods or services obtained through a bartering process. For example, consider a situation where you are a tax professional who agrees to trade your services representing someone at an audit of their small business in exchange for that person cutting down a tree in your home’s backyard. The tree-cutter must provide you with a 1099 form to be filed with IRS because the audit representation was a business expense. However, because the tree-cutting was a personal expense, you will not have to provide the tree cutter with a 1099.
Sometimes when you are exchanging tangible objects rather than services, bartering activities can create more than just ordinary income. Exchanges of property, such as trading one car for another, can result in capital gains or losses that must be reported. If it is business assets that you are bartering, you may have capital gains, ordinary gains, and depreciation recapture to report. If you barter ordinary property, like in the car example, and the fair market value of the car you receive is more than the amount for which you purchased the vehicle you traded away plus the cost of any improvements made to the vehicle, you will have reportable capital or ordinary gains, depending on how long you held the property.
As the above sections make clear, exactly how you must report to the IRS the fair market value of property or services obtained through bartering can be complicated to determine, as it will vary depending on the particulars of your situation. The best thing you can do to save yourself trouble down the line is to consult with our skilled Tax Lawyers and CPAs as the Tax Law Offices of David W. Klasing before filing your taxes. We can conduct an in-depth interview and review your records to determine precisely what must be reported and how. To schedule a confidential consultation, call our office today at (800) 681-1295.
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