Tax Implications of Crowdfunding
Tax Implications of Crowdfunding
With the advent of crowdfunding platforms, it has become easier for individuals and small or new entities to raise capital. According to the 2021 GoFundMe Giving Report, the platform has raised more than $15 billion since 2010. The report notes that the fastest-growing campaign categories are newlyweds and animals.
The easing of SEC regulations permitting private companies to raise equity capital through crowdfunding has opened doors that were be inconceivable just a decade ago. As limitless as the opportunities may be, beneficiaries and donors to crowdfunding platforms need to be aware of the tax implications.
According to a 2015 article in the Journal of Accountancy, “congress and the IRS have not addressed crowdfunding income specifically. Leaving scant guidance for CPA tax advisers whose clients may have this source of income.”
More recently, the Bradford Tax Institute writes that “there has yet to be a court decision or IRS ruling on the subject” and elaborates that the only guidance from the IRS is a couple of information letters guiding that “the IRS will examine all facts and circumstances…and use general principles of income inclusion to determine the proper tax treatment.”
Types of Crowdfunding
The Bradford Tax Institute notes there are four types of crowdfunding sources. Each of these present tax consequences.
Donation-based crowdfunding is composed of donations for causes such as medical expenses, economic hardship, emergencies, memorials, education, and non-profits.
Donations from such crowdfunding platforms are generally considered gifts and are not taxable to the beneficiary. The key qualification is that the contributions are gifts, which the Bradford Institute cites as “motivated by detached and disinterested generosity and made out of respect, admiration, charity or like impulses.”
An important exception noted by the IRS to this interpretation is “contributions to crowdfunding campaigns by an employer to, or for the benefit of, an employee is generally included in the employee’s gross income.”
Another caveat is that donations made to campaigns are not tax deductible for the giver unless made to a charitable organization known as a 501(c)(3).
Finally, any amount given to an individual over the annual gift tax exclusion would require the giver to file a gift tax return.
Crowdfunding sites such as Indiegogo and Kickstarter help startup-up entities and creative ventures to raise capital through rewards-based donations. Donators receive rewards but have no equity and are not creditors.
Donations received through rewards-based crowdfunding should be considered income. However, there are potential exceptions; the reward has no economic value, is not accepted, or donations are beneath the qualifying threshold to be awarded. Understanding which expenses are tax-deductible for beneficiaries of crowdfunding mitigates most potential issues. Startup costs are generally non-deductible as a fundraising expense. In this case, “up to $5,000 in startup expenses are deductible the first year a business begins operation, with any remaining amounts amortized over the next fifteen years.”
In 2016 SEC Regulation CF (crowdfunding) went into effect and now allows small private companies to raise up to $5 million a year in equity through crowdfunding.
While companies must be diligent in complying with SEC rules and filings, funds received are considered equity and not income.
Crowdfunding platforms have also allowed smaller companies and startups to raise capital efficiently through debt financing. Instead of utilizing a traditional bank loan, companies can obtain a loan from a platform such as Lending Club or Prosper.
In turn, the debt-based crowdfunding sites bundle a package of loans and “sell” them to investors.
Funds received are not classified as income. Interest expenses for business loans are tax-deductible expenses for the business.
Beginning in the 2022 tax year, the IRS requires payment processors to issue 1099s for anyone who receives payments exceeding $600 during the year. While the regulations don’t require a 1099-K for donation-based crowdfunding, beneficiaries may receive one. In such cases, beneficiaries should work with their tax preparer to properly report the donations as non-taxable donation proceeds. Participants in crowdfunding may benefit from seeking professional guidance on potential tax liabilities.
If you have received crowdfunding funds, and have questions about the tax liabilities, schedule a free tax planning strategy session.