Once upon a time, a very nice fellow came to our office and begged for help. Steve sheepishly admitted that he hadn’t filed tax returns for about ten years and the Internal Revenue Service was a bit unhappy with him. After a bit of prodding, Steve confessed that he was being pressured and threatened by IRS’s Criminal Investigation Division.
It was like pulling teeth, but we finally got the meat of his story. It turns out that the IRS had been investigating his boss, a major artist, for unreported barter income. Since his boss, let’s call him Leonardo, was so famous, the IRS wanted to make a landmark case against him. Now, Steve had been working closely with Leonardo for years. So, he ought to know the intimate details of Leonardo’s transactions. In fact, as his primary salesman, Steve may have brokered some of the trades – or benefited from them.
Why should the IRS care about barter?
It’s a huge, quiet and old industry. It is the perfect vehicle through which to hide taxable income.
Why would there be taxable income? After all, we are making an even exchange of values! I mean really, how much money could we be talking about?
Well, let’s say I trade you my accounting services and you give me spa for my home. I’ve generated business income in exchange for a personal expense. So, while you may have a transaction that is 100% business-related, I’ve just picked up $1,000 value tax-free. Suppose I do that with my hairdresser, my grocer, my gardener, and my housekeeper. I’ve now generated several thousand dollars worth of billable income and “spent” it on personal matters.
Many people live a large part of their lives this way. If you can effect enough trades, you could have $10,000, $20,000, even $50,000 worth of unreported income. The IRS wants the taxes on it! It could amount to millions of tax dollars.
Incidentally, handling all your barter through a club that tracks all the transactions would keep you out of trouble. All the trades are reported, both to you and the IRS. So all you need is a good tax pro (like an Enrolled Agent ) who can sort out the personal and taxable events.
Getting back to our story – I did my best to convince him that the IRS could not bring any criminal action against him for not filing tax returns – only for lying on them. So, since we needed to file for 10 years, it was in his best interests to come completely clean.
Tell me the whole truth. I pleaded with him to reveal all the transactions he could remember. After all, they were hot to convince him to testify – and I didn’t want to file tax returns where the IRS knew about income that I didn’t include.
After all, even if we only used the information I already had, his outstanding tax liabilities were going to be so high that he would never be able to pay them. So who cares if he owes $250,000 plus penalties and interest or a million dollars. We may as well tell the truth.
As it turns out, by the third time I re-did his tax returns, he finally revealed that he had traded one of Leonardo’s paintings for about $10,000 worth of dental work. More art for $15,000 worth of trips one year. Yet more art took care of his weekly dry cleaning bills. In one year, Steve used paintings to cover a substantial portion of his personal expenses. So, can you imagine how much his boss used for his very elegant, expensive personal life? I haven’t a clue – and don’t dare speculate.
Well, Steve submitted the tax returns. Then in front of the judge, IRS’s Criminal Investigation folks asked him about all his barter income. Steve claimed it was all reported on his tax return – they couldn’t touch him. Then, they asked if he had ever sold a painting to a certain wealthy collector. Steve said he hadn’t. They interrogator made him confirm that. Then he asked him if he recognized his endorsement on the back of a check for $80,000 that had been cashed at the collector’s bank.
Oops. Telling me all about the barter did no good – he didn’t come clean about the cash.
How does the story end? Oh yes, he was convicted. He never squealed on his boss.
Don’t even ask about the sentencing. You don’t want to know.
But what about Leonardo? He’s still famous and going strong.
I haven’t heard anything in the news about the IRS getting him…and it’s been nearly five years.
So, I guess the IRS didn’t get their landmark case, after all.
The moral? Barter may get you into trouble BUT never lie to your tax professional – or your attorney. They are the ones who save you.