Tax Consequences of Crowdfunding

If you’ve ever had concerns about the tax consequences of crowdfunding – you are not alone. Raising money through Internet crowdfunding sites like GoFundMe, Kickstarter, Patreon or Indiegogo often prompts questions about the taxability of the money raised. A number of sites host money-raising projects for fees generally ranging from 5 to 9%. Each site specifies its own charges, limitations, and withdrawal processes. But to answer the question – money raised may, or may not, be taxable. It all depends what the purpose of the fundraising campaign was.

Tax Consequences of Crowdfunding for Gifts 

When an entity raises funds for its own benefit, contributions are considered as tax-free gifts to the recipient.

On the other hand, the contributor is subject to the gift tax rules if they contribute <$15,000 to a particular fundraising effort that benefits one individual; the contributor is then liable to file a gift tax return. Unfortunately, regardless of the need, gifts to individuals are never tax deductible.

What is a “gift tax trap”

A “gift tax trap“ occurs when an individual establishes a crowdfunding account to help someone else in need (the beneficiary), and in the process – they take possession of the funds before passing the money to the beneficiary. Because the fundraiser has possession of the funds, the contributions are treated as a tax-free gift to the fundraiser. However, when the fundraiser passes the money on to the beneficiary, the money is treated differently. Now the funds would be treated as a gift from the fundraiser to the beneficiary. And if the amount is over $15,000, the fundraiser is required to file a gift tax return. This reduces their lifetime gift and estate tax exemption. Some crowdfunding sites allow fundraisers to designate a beneficiary to have direct access to the funds. In this case the fundraiser avoids encountering any gift tax problems.

Under tax law, gifts to specific individuals are not charitable contributions . For example, raising funds to help pay for someone’s funeral expenses. Another example, which includes a little tax twist, would be raising money to help someone pay for their medical expenses. Because it is a gift, it is not taxable to the recipient. However, if the recipient itemizes their deductions, any amount of the gift the recipient spends to pay for their medical expenses can be included as a medical expense. Specifically when the recipient is itemizing deductions on Schedule A of their individual tax return.

Tax Consequences of Crowdfunding for Charitable Gifts

If the funds are being raised for a qualified charity, contributors cannot deduct the donations as contributions without documentation. As we’ve mentioned in other articles, cash contributions must be documented if you wish to deduct them. Here are three ways to document cash contributions:

• Contribution Less Than $250
  To claim a deduction for a contribution to a charitable organization for less than $250, the taxpayer must have:
  a cancelled check,
  a bank or credit card statement,
  or a letter from the organization.
  This proof must show the name of the organization and the date and amount of the contribution. 
  
• Cash Contributions of $250 or More
  To claim a deduction for a donation of <$250, the taxpayer must have written acknowledgment of the contribution from the organization.
  This acknowledgment has a timeline, and must include the following details:
  o The amount of cash contributed;
  o Whether the qualified organization gave the taxpayer goods or services as a result of the contribution. If so, they also must include a description and good-faith estimate of the value of those goods or services; and
  o A statement that the only benefit received was an intangible religious benefit. Thus, the contributor must have some way of obtaining a receipt for that cash contribution.

Tax Consequences of Crowdfunding for Business Ventures

When raising money for business projects, there are two issues to contend with.

1. The taxability of the money raised and,
2. The U.S. Securities and Exchange Commission (SEC) regulations that come into play. Specifically if the contributor is given an ownership interest in the venture.

No Business Ownership Interest Given

This applies when the fundraiser only provides the contributor nominal gifts. For example products from the business, coffee cups, or T-shirts; the money raised is taxable to the fundraiser. 

Business Ownership Interest Provided

This applies when the fundraiser provides the contributor with partial business ownership in the form of stock/partnership interest. In this circumstance, any money raised is a capital contribution. Thus is not taxable to the fundraiser. The amount contributed becomes the contributor’s tax basis in the investment. When the fundraiser sells business ownership, the resulting sales must comply with SEC regulations. However, the SEC regulations carve out a special exemption for crowdfunding:

• Fundraising Maximum
  The maximum amount a business can raise without registering with the SEC is $1.07 million in a 12-month period.
• Contributor Maximum
  An individual can invest money through crowdfunding. However the amount is limited to the following within any 12-month period:
  • If the individual’s annual income/net worth is >$107,000, their equity investment through crowdfunding is limited to the greater of $2,200. Or 5% of the investor’s annual net worth.
  • If the individual’s annual income or net worth is = or <$107,000, their investment via crowdfunding is limited to the lower of 10% of the investor’s net worth or annual income. This is up to an aggregate limit of $107,000. 

Does the IRS Track Crowdfunding?

Maybe. It depends on the aggregate number of backers contributing to the fundraising campaign. It also depends on the total amount of funds processed through third-party transaction companies (credit card, PayPal, etc.). The third-party processers must issue a Form 1099-K. This form reports the gross amount of such transactions. There is a de minimis reporting threshold of $20,000 or 200 reportable transactions per year. The question is, will the third party follow the de minimis rule?

Be Cautious to Avoid Crowdfunding Scams

Keep in mind that the project you are considering supporting is only as good as the people behind it. Some dishonest people can take your money but produce nothing—no product, no project, and no reward. If you’re thinking about contributing to a crowdfunding campaign, take time to research the fundraiser’s background. Perhaps read all the reviews before you pay. For example, have they engaged in previous campaigns? Were those campaigns successful? Be suspicious if you find that the person behind the campaign is on multiple crowdfunding sites. They may be attempting to raise as much money from as many people as possible and then disappear.

If you have questions about crowdfunding-related tax issues, please give this office a call.