By Cliff Ennico

“I run a professional services firm in a small town.  Because of the poor local economy, I’m finding that more and more of my clients can’t afford to pay my fees, so they’re asking me to ‘swap’ my services for something they can do.  For example, an auto mechanic recently offered to do a tune-up on my car if I would give him X hours of my time without charge.  Is it legal to agree to deals like this?  And would I have to report this on my taxes in some way?” 

In difficult economic times, a lot of people resort to one of the most ancient forms of commerce – bartering, swapping or “horse trading”.  While our ancestors may have swapped chickens for corn, today’s barter transactions typically involve services – “I’ll do your oil change if you help me fill out my tax return.” 

The good news is that bartering is perfectly legal.  The bad news is that you can’t avoid paying income or sales taxes when you barter something instead of paying cash. 

You can barter things directly with someone else, or you can participate in a “barter exchange,” many of which now exist online, such as www.imsbarter.com or www.u-exchange.com.  Here’s how barter exchanges typically work:

• you create a “posting” offering something for sale on the exchange;
• either you or the exchange assign a “dollar value” to the products or services you offer for sale, and award you “credits” equal to the dollar value of the items you are bartering; and
• you can then use these “credits” to purchase goods or services being offered by other members of the barter exchange.

So what about taxes?  If you swap something for something having equal value, it’s a “wash” and there are no taxes to pay, right? 

Well, not exactly . . . 

In the IRS’ view, a barter exchange is really two separate transactions – you are “selling” something and “purchasing” something in return, even though no actual cash changes hands.  So the IRS requires you to report a barter transaction the same way you would report any other transaction – the market value of the goods or services you “purchase” are recorded as income on your Schedule C, and the market value of the goods or services you “sell” are recorded as an expense.  If the two transactions match up, then there is truly a “wash” and no income taxes are payable.  You may, however, have to pay sales taxes on the market value of the goods or services you receive – ask a local accountant or tax lawyer for details. 

If you are swapping goods and services on a “barter exchange,” you had better get this right, because the exchange is required by law to send you IRS Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” next January.  This form will show the market value of all of the items you “purchased” on the barter exchange, but not any of the items you “sold” – you will have to keep track of these separately and report them as “expenses” on your Schedule C. 

What if the market value of the item you receive in a barter transaction is disproportionately large or small when compared to the value of the item you trade away?  The IRS looks upon any disparity in barter value as income to the recipient – capital gains income if the item received is a “capital asset”, and ordinary income in all other cases.  So, for example, if you are a construction contractor, and I form your limited liability company (LLC) in exchange for your building an addition to my house without charge for labor, the IRS would require me to pay tax on the difference between the market value of the construction job (what you would normally charge) and the value of the LLC (what I would normally charge).  In a situation like this, you are well advised to pay cash, what the IRS calls “boot”, to make the values more equal. 

Also, you cannot avoid capital gains taxes by swapping an item that has appreciated in value.  For example, you buy a dusty old painting at a flea market for $10.  You have it cleaned by a local antiques dealer and discover that it’s an original Rembrandt worth $5 million.  Rather than sell the painting at Sotheby’s, you swap it with another collector for a Vermeer painting worth $5 million.  While the “swap” in this case would be free from tax, you would not be able to avoid the capital gains tax on the $5 million market value of the Rembrandt (less, of course, the $10 you paid for it). 

One last thing:  barter should be only a very small percentage of your business.  The last time I looked, the IRS, your mortgage bank, your landlord and your local supermarket will deal only in cold, hard cash.  If you’re thinking about paying your rent in chickens, please talk to your attorney first.