You may have thought there wasn’t any harm in trading services or goods with another business owner for something of interest or to fulfill a need of yours. However, watch out for the tax man if under audit.
Regrettably, it’s clear in the tax code that when a taxpayer receives goods or services in exchange for his services, the fair market value of the goods or services received is gross income. (IRS Reg Section 1.61-2(d)(1).
The fair market value of the goods and services received in a barter transaction is the price normally charged by the transferring party. Thus, a CPA firm that accepted goods and services from clients in exchange for accounting services had to include the goods and services in income at the normal retail price—not at a discounted value based on the clients’ inability to pay cash. In fact, where the services are rendered at a stipulated price, the value of the services is the stipulated price in the absence of evidence to the contrary. (see Rooney v. Commissioner, 88 TC 523)
To be on the safe side, if you trade with another business for your goods or services, send them a 1099 next January. Of course, it would be a good idea you plan to do this before ‘the trade’ or you may get a nasty letter next year. In turn however, if your trading for a good or service that is useful in your business, you can have them send you a 1099 and the two transactions will offset each other so there isn’t a negative tax impact.
Bitcoin began, where trust in trading goods and services, left off. After an article by Satoshi Nakamoto, in 2008, describing the possibility of a ‘A Peer-To-Peer Electronic Cash System”, just a few months later in 2009 the bitcoin network came into existence.
Although it took the IRS to catch up and respond to this phenomenon, they simply stated they were aware that “virtual currency” may be used to pay for goods or services, or held for investment, and that virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.
They went on further to state that virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency.
Example: You paint someone’s house for $3,500 in cash, or $3,500 in bitcoins. In the U.S., you just created earned income and you would need to report that as such. Frankly, whether you received the $3,500 in cash, bitcoins, or exchange for 3,500 tennis balls, it’s still reportable income.
Thus, the sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability. (see IRS Notice 2014-21)
Bottom line, the IRS is clear in its recent statements and actions that Bitcoin qualifies as virtual currency. Now with that said, there are a lot of complexities when it comes to Bitcoins in other scenarios. What if you have capital gains, or if you ‘mined’ for bitcoins. Certainly, if you are working in a significant way with Bitcoin, you will want to brush up on your tax law just to be safe.
I realize this particular nuance of tax law drives some of you more independent types crazy, but it’s better that you know the rules or get caught unaware. Remember, ignorance of the tax code isn’t a defense. Aren’t you glad you read my Blogs?
Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the book “Lawyers are Liars- The Truth About Protecting Our Assets”. and “What Your CPA Isn’t Telling You- Life Changing Tax Strategies”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at www.markjkohler.com.