Barter Exchange Reporting Relief,

January 14, 2000

Author: Charles C. Hwang.

Table of Contents

In early January of 2000, the Internal Revenue Service ("IRS") released Notice 2000-6, in which the IRS announced that the existing barter exchange reporting requirements would not apply to any exchange in which the fair market value of services or property received in the exchange is less than $1.00.

Notice 2000-6 does not expressly refer to the Internet or to e-commerce. However, remarks made by IRS officials at the time Notice 2000-6 was released indicate that the notice was intended to provide some relief to exchanges of Internet advertising. Moreover, since many Internet-based businesses ("e-businesses" for purposes of this memorandum) engage in or facilitate barter transactions, barter exchange reporting requirements may be of general interest to many companies.

In sum, the IRS Notice provides only partial relief from what may be a burdensome (and unnecessary) requirement for e-commerce companies. The Notice requests comments by April 4, 2000 on a number of questions, including possible expansion of the exemption.

In order to understand the significance of the new IRS policy, it may be helpful to examine briefly (1) the general federal income tax treatment of barter transactions and (2) the barter exchange information reporting requirements, which were created by and pursuant to a 1982 statute. After examining these background matters, we discuss Notice 2000-6 below.

Barter Transactions

Barter transactions are generally fully taxable to both parties to the exchange. That is, the mere fact that the buyer and the seller of property or services choose to make settlement using non-cash consideration does not exempt the transaction from income tax consequences. 1 If this were not the case, there would be many opportunities to side-step the income tax by arranging barter transactions rather than cash transactions.

Thus, both parties to a barter transaction will have income to the extent of the value of the property or services exchanged. Assuming that services are exchanged in an arm's-length transaction, the amount of income inclusion to each party should be the same, and should reflect the fair market value of the goods or services exchanged. Furthermore, assuming that the transaction is in all respects a business transaction, both parties probably also have offsetting business deductions in the same amount. The timing of the deduction may be delayed in some cases due to a capitalization requirement, or may be delayed because of certain tax accounting rules (including the "economic performance" rule). In the typical case, however, the deduction may be fully available in the same tax year as the year in which the income is recognized, which means that both parties may have no net income from the transaction, regardless of the valuation of the property or services exchanged.

The situation is somewhat different, however, if there is a personal element to the transaction. If a plumber repairs a music teacher's residential plumbing in exchange for piano lessons for the plumber's child, both parties recognize income, and in all likelihood neither party has an offsetting deduction. The procurement of piano lessons is probably a personal, and not a business, expense. Likewise, the repair of the plumbing in one's residence is probably a personal, and not a business, expense. 2

Hence, the tax avoidance potential is clearly much more of a problem when individuals are parties to a barter transaction.

While the tax rules are fairly straight-forward, the IRS has administrative difficulties in finding barter transactions that are not being reported accurately. In the case of the hypothetical plumber and the music teacher, if the parties failed to report the appropriate amounts of income, the IRS would have little chance of knowing that the barter transaction had happened. In the absence of barter exchanges, discussed below, this problem would not necessarily be acute, since barter transactions are difficult to arrange and far out-numbered by cash transactions. Most people prefer to deal in cash precisely because it would be time-consuming and inefficient to find an acceptable barter transaction equivalent to cash.

Barter Exchange Information Reporting

In the 1970s and 1980s, organizations of individuals or companies - called "barter exchanges" - began to emerge. Barter exchanges attempted to make barter transactions more common by providing an exchange mechanism. The seller of goods or services would obtain "credits" from the barter exchange that could be used to purchase goods or services from another member of the barter exchange. These "credits," which went by various names, were usually stated to have a face value of one dollar. By partially monetizing the barter transaction, the barter exchange hoped to encourage these transactions. The less scrupulous barter exchanges also suggested that barter transactions could be used to avoid taxes. In the hypothetical transaction discussed above, the plumber without need of piano lessons could fix the music teacher's plumbing, be paid in barter exchange credits, and then use such credits to purchase some other goods or services from another member of the barter exchange.

The development of barter exchanges alarmed both Congress and the IRS. In 1982, Congress passed a law requiring "barter exchanges" to report barter transactions. By placing the onus of reporting information on the barter exchange, Congress hoped to reduce the cost of auditing members of the barter exchange. While in theory the provision of services or the transfer of goods in a barter transaction could, even in the absence of the barter exchange reporting requirements, subject the service provider or transferor to an information reporting requirement (pursuant to Code section 6041, discussed below), enforcement of this information reporting requirement presents the same enforcement problems as enforcement of the underlying tax liability.

Code section 6041 imposes a general requirement that if a person makes, in the course of a trade or business, payment of any compensation for services rendered aggregating $600 or more in a calendar year, such person must report the transaction both to the IRS and the payee on Form 1099. Because the Treasury Regulations under section 6041 specifically require the reporting of property transferred as compensation, Treas. Reg. § 1.6041-1(e), the requirement extends to barter transactions. However, there are broad exceptions to the information reporting requirement under Code section 6041, including an exemption for transfers to most corporations. Treas. Reg. § 1.6041-3(q). In contrast, regulations issued under the separate Code section specifically covering barter exchanges require that a barter exchange must report barter transactions even with corporate members or clients. Treas. Reg. § 1.6045-1(f)(2)(ii) (reporting required on aggregate annual basis).

Hence, a business that qualifies as a "barter exchange" is subject to a more extensive information reporting regime than a business that is not a "barter exchange." Under Code section 6045, a "barter exchange" is defined to mean "any organization of members providing property or services who jointly contract to trade or barter such property or services." (Emphasis supplied.) For purposes of Code section 6045, a "barter exchange" is defined as a kind of "broker." That is, the requirements of Code section 6045 apply to "every person doing business as a broker," which is defined to mean "(A) a dealer, (B) a barter exchange, or (C) any other person who (for a consideration) regularly acts as a middleman with respect to property or services." (Emphasis supplied.) By implication, each kind of "broker" is a person who regularly acts as a middleman with respect to property or services. 3 It appears that these statutory provisions, taken together, require a "barter exchange" to have a role as a "middleman." The Treasury Regulations, on the other hand, define "barter exchange" as "any person with members or clients that contract either with each other or with such person to trade or barter property or services either directly or through such person." This definition leaves open the possibility that a business that engages in frequent 4 barter transactions may be subject to the barter exchange reporting requirements.

The better view is that the Treasury Regulations cannot relax (and should not be interpreted to relax) the statutory requirement that a "barter exchange" have a "middleman" role. That is, an e-business that engages in frequent barter transactions during a year for its own account and not as a means of facilitating barter exchanges between its clients should not be treated as a "barter exchange." This view is supported by the language of the statute as well as with the context within which the statute was enacted.

As in the case of reporting pursuant to Code section 6041, a barter exchange is required to file reports both with the IRS and with the payee. The Form used is Form 1099-B, Proceeds From Broker and Barter Exchange Transactions.

Penalties and Back-Up Withholding

In the case of a willful failure to file barter exchange reports with the IRS, the penalty is the greater of $100 per report or 5% of the aggregate amount of items to be reported. Code section 6721. If such failure is not willful, the penalty is $50 per report but no more $250,000 for each calendar year.

In the case of a willful failure to file barter exchange reports with the payee, the penalty is the greater of $100 per report or 5% of the aggregate amount of items to be reported. Code section 6722. If such failure is not willful, the penalty is $50 per report but no more $100,000 for each calendar year.

Thus, in the case of a willful failure to file barter exchange reports with both the IRS and the payee, the penalty can be as much as 10% of the aggregate amount of items to be reported. Note that it is the fair market value of the property or services that would be reportable under the barter exchange rules. This is a gross amount and is not limited to the net income of either party.

No penalty will be imposed under either Code sections 6721 or 6722 if the failure is due to reasonable cause and not willful neglect. Code section 6724.

In certain circumstances, a payor may be required to withhold 31% of certain "reportable payments." Code section 3406. Payments subject to the barter exchange reporting requirements qualify as reportable payments. Hence, if the barter exchange reporting requirements apply, back-up withholding may also be applicable.

Applications to E-Businesses

It has been said that the Internet tends to drive information costs to zero. Finding the needle you want in the global haystack has been made at least possible, if not yet effortless, by the development and growth of the World Wide Web. Since one of the barriers to barter transactions is the cost of information about who is offering what you need and who desires what you are offering, one would expect the number of barter transactions to increase because of the availability of the Internet. Some e-businesses may, in fact, deliberately facilitate barter transactions as part of their business plans. Other e-businesses may incidentally facilitate barter exchanges. 5 In either case, in order to avoid inadvertently violating the barter exchange reporting requirements, each business should determine whether its activities are such that it qualifies as a "barter exchange" for purposes of Code section 6045.

Notice 2000-6

Notice 2000-6 was intended to help taxpayers by providing relief from the barter exchange reporting requirements. However, the extent of this relief is quite narrow. Rather than exempting exchanges of electronic advertising categorically (which was the relief originally requested by taxpayers), or exempting other categories related to e-businesses, the IRS chose to exempt transactions in which the fair market value of the property or services received is less than $1. The relief is thus tied to a valuation determination. It has been our experience that valuation issues are among the most vexing of the issues that arise in a tax audit, and are among those raised most frequently by examining agents. If an e-business company is audited, it may be difficult to prove that a transaction falls under the $1 threshold.

It is also important to note that examining agents look at valuation questions with the benefit of hindsight. If the taxpayer can obtain and preserve any contemporaneous valuation information (such as a record of potentially analogous actual cash transactions with unaffiliated persons), such information can aid the early resolution of audit issues.

Notice 2000-6 applies to information returns that would be due on or after January 5, 2000. In the case of information returns due before January 5, 2000, the IRS will not assert penalties for failure to report under Code sections 6721 and 6722 if the transaction falls below the $1 threshold discussed above.

Notice 2000-6 also solicits comments from interested taxpayers as to the form the final regulations under Code section 6045 should take. In particular, comment is sought with respect to the following four questions:

  1. Whether the regulations providing an exception to the reporting requirements for cases in which the fair market value of property or services received by the member or client falls below a de minimis transactional threshold (such as that described in Notice 2000-6) should only apply if the total fair market value of property or services received by the member or client during a calendar year does not exceed an aggregate threshold;

  2. Whether the regulations should allow annual aggregate reporting with respect to amounts received by noncorporate members or clients;

  3. Whether the regulations should specifically require annual aggregate reporting, rather than transactional reporting, with respect to transactions involving certain types of property or services; and

  4. 4. Whether the regulations should apply special rules to certain bartering transactions involving the provision of electronic or Internet services.

Written comments should be submitted by April 4, 2000.


1 If like-kind property is exchanged, the transaction may not result in the recognition of gain or loss if Internal Revenue Code ("Code") section 1031 applies.

2 Except perhaps in a "home office" context.

3 See Robinson v. United States, 95-1 U.S.T.C. (CCH) 50,222 (M.D. Fla. 1995).

4 A barter exchange is not required to report for any calendar year in which there are fewer than 100 covered transactions. Treas. Reg. § 1.6045-1(e)(2)(ii).

5 For example, a business that creates an "e-money" medium of exchange for use on the Internet can be seen as a form of barter exchange. But in a 1997 ruling, the IRS stated that the purveyor of such e-money would not be treated as a barter exchange. The IRS might well not issue this ruling again if similar facts came before it now. A successful e-money system, after all, could cause the proliferation of untraceable, anonymous transactions on the Internet and remove these transactions from the effective scrutiny of the IRS and other tax authorities.

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Charles C. Hwang
Partner – Washington, D.C.
Phone: +1 202.624.2626