What an accountant should know about it.
BY PHYLLIS MALITZ, CPA, is the principal of Phyllis Malitz & Associates, Ltd., a CPA firm with offices in Wilmette and Chicago. She is a member of the federal income taxation committee of the Illinois CPA Society and the barter accounting standards work group of the International Reciprocal Trade Association.
EXECUTIVE SUMMARY
BARTER IS MORE than just a fair exchange of goods and services between two businesses. It often provides both financial and marketing bonuses for both sides as well.
ITS BEST TO WORK through a barter exchange network, which acts as a broker for its clients goods and services. Such networks have thousands of clients, making them a viable source for many business needs, such as office equipment and supplies, printing, advertising, cleaning and maintenance services, professional services and travel and entertainment.
ALL BARTER INCOME is on the cash basis, and the IRS treats barter transactions as income received for both accrual-basis and cash-basis clients. The value of trade dollars received must be included in gross income for the tax year in which they are credited to the clients account.
SOME OF THE GOALS barter can achieve: marketing advantage, debt collection, cash conservation and lines of credit particularly when a business needs to borrow money to relocate, expand or launch a marketing program.
Accounting For Barter
The Tax Equity and Fiscal Responsibility Act of 1982 classifies barter exchange networks as brokerages, so they are required to file 1099-B forms listing the sales of client companies. Just as in the case of a stock brokerage, the barter exchange sends a copy to each client for use in tax preparation. All barter income is on the cash basis. Perhaps the most important barter accounting concept is that the IRS treats barter transactions as income received for both accrual-basis and cash-basis clients. The value of trade dollars received must be included in gross income for the tax year in which they are credited to the clients account. Since tax is due on this income in the year it accrues, companies that are profitable should avoid having unspent trade dollars at the end of the fiscal year. This is not a concern during unprofitable years. As long as barter income does not put the company into a profit situation, it will not be taxed. In the event of year end excess barter credit, a network can arrange tax-deductible, charitable contributions using barter.
Is Barter an IRS Target?
Perhaps the most entrenched myth about barter is one that many CPA's themselves perpetuate out of lack of current information is that it flags a company for an IRS audit. Source of the myth: Between 1979 and 1983, the IRS put considerable resources into a
project to examine the barter business. During that period, all barter exchange networks were audited, along with a sample of their clients returns. The study disclosed that businesses that used barter had a better than average record of tax compliance. Today,
a company that barters has the same chance of being audited as any other organization.
Barter can be used as compensation, too. A company can give the bartered goods or services as a bonus or as part of a compensation package without tapping cash. Many companies conduct barter bonus or sales incentive programs, using everything from restaurant certificates to resort trips.
Just as business expenses covered through barter are deductible to the same extent as cash, barter used as compensation is subject to personal taxes. Barter used as a bonus or compensation for an independent contractor must be included on the contractors 1099 as non-employee compensation, and all barter compensation for employees must be taken into account on their W-2s. Barter compensation is subject to federal and state withholding, FICA, FUTA and SUTA. Taxes, of course, must be paid in cash.
Barter Goals
Accountants can advise clients to use barter to achieve specific business goals, including Cash conservation. Paying for business expenses with trade dollars leaves more cash available for the payment of strictly cash expenses.
Barter lines of credit. Barter can be particularly useful when a business needs to borrow money to relocate, expand or launch a marketing program. A barter line of credit may be easier to get than bank credit because barter exchange networks look at a companys capacity to pay back through demand in the network rather than through traditional collateral. Many of the products and services associated with moving, remodeling or marketing are available in barter exchange networks. Interest on barter lines of credit is paid in trade dollars.
Marketing advantage. Because barter purchases represent lower out-of-pocket cash costs, trade dollars often can be earned with little increase in overhead and without advertising or marketing expense.
A barter network keeps clients informed of new products and services available for barter. Some networks hold events such as holiday shows, where clients have an opportunity to meet each other and examine each others products or services.
A further advantage of barter arises directly from the makeup of barter exchange networks. Because radio, television and print media companies can run additional advertising spots or ads with little increase in overhead, they often participate in exchange networks. This means network clients can finance ad campaigns by paying with their own products or services.
Help with collection. Businesses can use barter to get value out of otherwise uncollectible debts. Instead of chasing cash, which might be nonexistent, the creditor can give the debtor company the option to pay with its product or service. That product or service is placed in the barter exchange network and its value in trade dollars is transferred to the creditor, who can spend it in the network. A company also can use barter to pay a debt by offering to transfer credit it has earned to a creditor.
The Best Candidates
Theoretically, any company can barter to its advantage if the network offers products or services the company requires and if there is a demand for the company's products or services in the network. Some companies may be particularly well suited to barter; the best candidates are those with High T&E costs. Restaurants, hotels, stadiums and even some airlines barter because they have excess capacity in the form of empty seats and rooms that can be traded for products and services for which they would normally pay cash. However, T&E taxes and gratuities must be paid in cash. Conversely, barter exchange network clients with high T&E expenses can benefit because of the number of travel and hospitality choices available. This includes companies that offer travel incentives to high performers.Products and services needed by hospitality firms. Companies that sell or repair furniture, plumbing, air-conditioning and heating systems, and those that offer cleaning, painting and other services needed by restaurants and hotels, find their products and services are in high demand in the network.Excess inventory or capacity. A company with excess inventory should consider barter before liquidation because barter offers the opportunity to sell at full price. A plumbing wholesaler with 500 faucets might earn trade dollars from a Caribbean resort that would happily take such an item in quantity in exchange for vacant rooms that still another client in the network might use for a company retreat. Companies with excess capacity are barter candidates because capacity can be turned into extra business that costs the company only the direct costs of producing their goods and services.Seasonal fluctuations. For some companies, barter may not be beneficial at certain times of the year. A furrier, for example, may be too busy in the fall and winter seasons, but during the slow spring and summer, when inventory still on hand is moving slowly and cash flow is light, barter business probably would be welcomed.
A new product or service. Barter can be used in several ways to lower the risk of introducing a new product or service in test marketing, for example because it costs nothing in promotional expense other than barter exchange fees. In addition, the direct cost of promoting a new product can be offset by trading the product or service for advertising through the network.Understanding the uses of barter and which clients can benefit from it improves accountants adviser role. The CPA with clients that have decided to use barter should advise them to limit barter income to the extent of their ability to spend the trade dollars they earn. Companies new to barter usually find it helpful to begin slowly, to get a feel for the ebb and flow of trade dollars.