Taxation of Barter, Swapping, and Gifts

We know the IRS doesn’t intend to tax everything we give, swap, exchange, and trade with one another, but it’s very hard to know where the IRS intends to draw the line.  We can derive hints from a few things the IRS has stated and from rules in the tax code.

First of all, here are some general rules about income, barter, and gifts:

• Income: With some exceptions, gross income is taxed, whether it comes in the form of money, property, or services. ¹

• Barter: The value of something received through barter is income, and is therefore taxed, with some exceptions. ²

• Gifts: Gifts are generally not counted as part of gross income, and are therefore not taxed for the recipient, with some exception. ³

In sum, the IRS considers bartered goods and services to be income, and considers gifted goods and services not to be income.   However, there are infinite ways to give and receive, and the line between barter and gifting could be unclear.  Furthermore, it’s hard to know how far the taxing of barter income actually extends. The IRS rule on barter, as written, appears to tax any good or service received in exchange for any other good or service.  In practice, however, it is probably not such a blanket rule. The IRS doesn’t seem to concern itself with casual and non-commercial exchanges of goods or property.   Administratively, it would be a hassle both for the taxpayer and for the IRS to report the plums I gave my neighbor in exchange for his figs.  Unfortunately, it’s hard to say at what point a barter arrangement has become sufficiently formal or commercial to be something that should be reported.

A Middle Category: “Swapping”

Swapping is not a recognized category under the law, but I often use the word “swapping” to refer to the casual and non-commercial ways that people exchange things, such as: “I’ll give you some of my home-grown zucchini in exchange for some of your basil.”  Swapping falls somewhere in between barter and gifting.  Swapping is like gifting, to the extent that parties are likely to give to each other even without an agreed-upon exchange, and because the value of what is being exchanged may not be anywhere near equal.  However, swapping is somewhat like barter to the extent that there is direct and immediate reciprocity.

We have begun to use the word “swapping” to distinguish certain exchange activities from those that the IRS or other regulators consider to be “barter.”  For example, in 2011, at least one staff member at the City of Oakland, CA, Planning Department declared it to be illegal for residents to barter with homegrown vegetables. ⁴ The staff person used the word “barter” to refer even to more casual swapping of homegrown food among friends.  This misguided declaration was harmful, and even made its way into The Atlantic. ⁵ To the extent that commercial activities are generally prohibited in residential areas, it is true that commercial barter would also be prohibited.  However, the casual swapping of vegetables among friends and neighbors is quite likely considered to be a customary accessory use of a residential property, and would, therefore, not be a violation of a zoning ordinance.  Since the regulators in that case were unwilling to recognize the difference between commercial barter and casual barter, we have found it useful to use the word “swapping” instead of “barter,” to call attention to the fact that it is generally legal for people to provide for one another casually and non-commercially.

Federal tax regulations and the IRS have even hinted that casual and non-commercial exchanges are not meant to be taxed, but we come to this conclusion in a somewhat roundabout way.  The tax regulations state that a group that facilitates “informal exchange of similar services on a noncommercial basis” is not considered a “barter exchange” and is therefore not subject to the requirement to report transactions of its members.  The regulations even contain an example of carpoolers swapping rides with one another:

 “Example 3.  A, B, and C belong to a carpool in which they commute to and from work. Every third day, each member of the carpool provides transportation for the other two members. Because the carpool arrangement provides solely for the informal exchange of similar services on a noncommercial basis, the carpool is not a barter exchange within the meaning of paragraph (a)(4).”⁶

 This regulation does not actually say that the carpoolers are not taxed on the value of their rides; it merely says that the group is not required to issue 1099-B forms to its members.

Similarly, one IRS Private Letter Ruling examined a time bank and determined that it was not a barter exchange subject to the requirement of reporting every transaction.  In determining this, the IRS acknowledged that the exchanges taking place were informal and non-commercial.  It was significant that 1) participants had no contractual right to receive services in exchange for the favors they do for others, and 2) services were not bargained for at market rate, but were provided on an hour-for-hour basis, without regard to the market value of such services.  Nevertheless, the IRS was unwilling to discuss whether participants would be taxed on the value of services they receive.  The opinion ends with: “No opinion is expressed concerning whether a member earns income as a result of the member’s participation in the program.”⁷

I don’t blame the IRS for not wanting to make rules about what exchanges are or are not taxable.  However, this does leave taxpayers to make their own good-faith determinations.  As a general rule, when we barter for something at market rate, provide goods and services we normally provide as a business, or make a contract to exchange goods and services, we will likely realize taxable barter income.

For example, I acknowledge that if I were to join a time bank and provide two hours of legal services in exchange for “time dollars,” and if I spend those time dollars to receive two hours of services from an auto mechanic, I would likely pay taxes on the value of the auto mechanic’s services.  In spite of the fact that I had no contractual right to receive those services, and in spite of the fact that this is not a market-rate exchange, I recognize that, because I am in the business of being a lawyer, this is a more commercial-like transaction of the sort that the IRS would likely want to tax.

In contrast, if I join the time bank and spend two hours walking someone’s dog, then I “pay” my neighbor “time dollars” to take me on a historical walking tour of the neighborhood, I would likely not report the value of the tour on my taxes.  However, this is merely my own good faith determination that the IRS doesn’t intend to tax the value of the tour.  There is no bright line rule here, and it may turn out that I’m wrong.

What is a Gift?

⁸It helps to further unwrap the legal definition of “gift” under federal tax law. ⁹ The U.S. Supreme Court, in Commissioner v. Duberstein,¹⁰ has given us some guidance in this regard. Here are some quotes from the Supreme Court, along with my own summaries in bold:

1. Gifts arise from generosity: “A gift […] proceeds from a detached and disinterested generosity, out of affection, respect, admiration, charity, or like impulses.”
2. Gifts don’t come from a moral or legal obligation: “If a payment proceeds primarily from the constraining force of any moral or legal duty, […], it is not a gift.”
3. Gifts are not given with an anticipation of return: “If a payment proceeds […] from the incentive of an anticipated benefit of an economic nature, it is not a gift.”
4. Gifts are not given as a payment for something: “Payment made in return for services rendered is not a gift.”
5. The intention of the giver is what matters: “In determining whether a transfer of property is a gift, […] the controlling factor is the intention with which the transfer […] has been made.”

Even with the clues the Court has given us, the concept of a “gift” is still somewhat unwieldy.  If the authenticity of a gift is ever questioned by the IRS, the judge or other ruling body must attempt to gain insight into the thoughts and feelings of the giver, to guess at his/her motives and intentions. They would have to rely on vague criteria, such as the existence of a friendship, the non-existence of a business relationship, and other quasi-objective factors to guess at what the giver was feeling.

Given the criteria, it’s easy to see how a gift could transform into income, simply because of a slight change in motive.  For example, imagine that, for years, I make soup for my elderly neighbor, simply as a kind gesture. Then, I go through a rough financial time after setting my kitchen on fire.  My neighbor, who just received a large inheritance, gives me $1,000 to help me pay for the damage.  These gestures do seem to arise from pure generosity and charity, so hopefully I wouldn’t have to include the $1,000 in my income.  But what if she gave me the check and said, “The soup has been so helpful to me over the years, but I’ve never been able to return the favor.  I feel I should compensate you somehow!”  Now there is a question: Is she giving me money out of a feeling of obligation or in the spirit of compensating me?  If so, does that mean the $1,000 is income to me?

Since the circumstances and intentions surrounding every gift could vary, the safest thing to do is to independently analyze every gift received to determine whether it should be included in taxable income.  Considering the criteria listed above, the person receiving the item would want to consider the intentions of the person that gives.  If it appears that a gift comes as payment for something the recipient has done or will do in the future, it may look more like income.

Paying Tax on Barter Income

First Rule: Do Not Send Soup To the IRS

An unfortunate fact about the taxation of non-dollar income is that the IRS requires that taxes be paid in dollars.  If the IRS considers 50 jars of soup to be “income,” it might, theoretically, follow that tax liability could be satisfied by sending eight jars of soup to the IRS.  Unfortunately, we don’t have that option at this time, and it requires everyone to keep enough of a toe-hold in the dollar economy to be able to pay taxes in dollars.

Note, however, that the idea of paying taxes in something other than cash is not an outrageous idea.  As local currency expert Mira Luna has suggested, there should be a program that allows us to fulfill our tax liabilities by performing community service.  Such a program could be like a time bank for paying taxes.  In my hypothetical soup case, since I receive almost no cash for my soup, I could put in a few hours a week volunteering at a nonprofit soup kitchen to satisfy my tax liability.

Determining The Value of Barter Income

Determining the value of the barter income will also be a challenge.  According to the IRS, “if services are paid for in property [or in exchange for other services], the fair market value of the property [or services] taken in payment must be included in income as compensation.”¹¹ Fair market value is a dollar amount that is based on what people in society at large are willing to pay for something.  The irony and difficulty of this requirement is that many barter transactions take place outside of the marketplace, and the elements of generosity, cooperation, and community skew the price.

Another tricky piece of this is that we must overcome the law’s presumption that a barter transaction always entails an exchange of two things of equal value. The law states that (emphasis added) “if the services are rendered at a stipulated price, such price will be presumed to be the fair market value of the compensation received in the absence of evidence to the contrary.” ¹²

What this means is that if a lawyer advertises services at $200 per hour, but agrees to provide an hour-long consultation in exchange for a bag of home-grown vegetables, it is unlikely that the stipulated price of $200 will be equaled by a bag of vegetables.  The lawyer shouldn’t have to report $200 of income, but the law presumes that she should, “in the absence of evidence to the contrary.”  To maintain such evidence, she should make a reasonable determination of the fair market value of the vegetables she receives, keep a written record of what she received and how she determined the value, and then report that amount as income.  That way, if she is ever audited, she has a record containing the required “evidence to the contrary.”

Reporting Barter Income

There are generally three places on an individual tax return where barter income might be reported. ¹³  If the income is earned in connection with a sporadic activity or hobby, it would likely be reported along with “Other Income,” and the type of income could be listed as “barter.”  If the income is earned in connection to a business, it would be calculated into business income on a Schedule C.  If a good or service is received in lieu of receiving a rent payment, the value would be reported as rental income on Schedule E.

Note that if people barter and receive for goods and services necessary to the operation of a business, the value of goods and services “paid” in the exchange could be deductible as a business expense.  For example, if an accountant provides $1000 worth of services to a web design business, and the web design business provides $1000 worth of services to the accountant, they each report $1000 of income, and deduct $1000 of business expenses (since accounting fees and web design fees are presumably business expenses for each).  The net effect is likely that no taxes are paid.

Taxation of transactions using virtual currencies

In 2014, the IRS released a notice describing how general tax principles apply to transactions using convertible virtual currencies (IRS Notice 2014-21), most likely in response to uncertainty around how to properly report BitCoin transactions. For federal tax purposes, virtual currencies are treated as property. This means that general tax principles applicable to property transactions also currently apply to virtual currencies transactions. The guidance also states:

• Taxpayers receiving virtual currencies for goods or services must include the fair market value of the virtual currency as of the date the currency was receive, in U.S. Dollars, when computing gross income;
• Virtual currencies transactions are subject to the same information reporting requirements as property transactions;
• Virtual currencies are not treated as foreign currency for foreign currency gain or loss;
• Exchanging virtual currency results in either capital gain/loss (for investments/securities) or ordinary gain/loss (for exchange of goods/services);
• “Mining” virtual currencies results in gross income that must be reported at the fair market value of the virtual currency in U.S. Dollars;
• Virtual currency received by an independent contractor for services performed constitutes self-employment income and must be reported in U.S. Dollars at the fair market value as of the date the currency was received;
• Virtual currencies can be considered wages and, if used as remuneration for services provided, are subject to federal income tax withholding, FICA tax, FUTA tax, and must be reported on W-2.

Please see the full IRS Notice for more details on the above issues.

This is a relatively early ruling specifically dealing with “convertible virtual currencies,” and not covering the tax implications of other types of currency transactions not falling under the definition of “convertible virtual currencies.” The IRS is actively seeking more public input on the overall tax treatment of virtual currencies, so their current guidance could very easily evolve as they receive more input. To submit input to the Treasury Department and IRS:

“The Treasury Department and the IRS request comments from the public regarding other types or aspects of virtual currency transactions that should be addressed in future guidance. Comments should be addressed to:

Notice.Comments@irscounsel.treas.gov.

Taxpayers should include “Notice 2014-21” in the subject line. All comments submitted by the public will be available for public inspection and copying in their entirety.”

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