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Free Barter and IRS – Taxation Essay Sample

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Introduction

Barter can be defined as an economic structure whereby goods or services are directly exchanged for other goods and/or services without a medium of exchange, such as money (O'Sullivan et al. 2003).  It is one of the oldest forms of human economic activity and precedes monetary economies.  While the idea of barter may appear old-fashioned to some nowadays, it still remains serving an important economic and social function.  One of the main reasons money has largely replaced barter in modern industrial economies is the high degree of transaction costs involved in finding a potential barter partner with complementary wants and needs. Regardless of barter's high transaction costs and scarcity of mutually complementary wants and needs, as confirmed by the Dec.2009 /Jan.2010 issue of Monocle magazine, it accounts for 30 percent of the world's total business (Global 2010). In addition, with the recent economic recession, it is on the rise and becoming more conventional. The internet is also providing ways to optimize for the double coincidence of wants problem, making it easier to find potential barter partners. Craigslist is one of the important barter sites for many communities, it achieved over 100 percent increase in barter postings between 2008 and 2009 (Barter Economy 2009). The IRS reports confirmed that "Internet has provided a medium for new growth in the bartering exchange industry" (Tax Topics 2010).

However, while Craigslist and other classified ad sites provide a way for users to publish their barter preferences, browsing through hundreds of postings is often a time consuming process and does not guarantee satisfactory results. There is also the issue of trust when dealing anonymously with strangers over the internet. In addition, other existing online barter exchanges like Dibspace usually rely on a "trade currency" systems pegged to the US dollar for assigning value to the goods and services being swapped, and are thus more like micro-currency systems than true barter,

Taxation on Barter

Lederman [2007] suggested that the income generated from the sale of virtual goods and services be included in gross income for federal income tax purposes consistent with IRC Section 61 because each participant has property rights associated with his or her underlying virtual self-created property; and therefore, sale or exchange represents a realization event and should be taxed.  Although the question of income realization is indisputable, the more challenging question to address is when this income should be recognized.  He further stated that income could be recognized when the virtual assets or services are sold goods such as in-game or when the participant converts in-game profits into real-world currency.  Both options might be justified using existing tax policy, depending on the conditions under which the game is played. Nevertheless, it may not be clearly discernable which alternative is preferred.   

While Lederman's assertions about the generation, ownership, and transfer of intellectual

property in-game are accurate, these factors, by  themselves, are not the only items that should be considered in evaluating when virtual income should be recognized for federal income tax purposes. Another factor to consider is whether a participant's accumulation of virtual assets is subject to a substantial risk of forfeiture. The fact that any gain or loss occurs in the game will be irrelevant if the game imposes restrictions on players that make it impossible to convert in-game income to real-world currency.  In other words, if a substantial risk of forfeiture exists, then any income that a player generates will be held in a currency that is essentially worthless until or unless it is redeemed for cash.

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