Be Ready to Launch
By Carolyn Bourgoin, CPA
Crowdfunding has become a popular vehicle to raise money for personal, charitable, or business endeavors due to its ease of use and accessibility. However, many businesses and individuals who enter into a crowdfunding campaign have not considered potential tax implications prior to launching a campaign.
Here’s how it works. Websites such as Kickstarter, Indiegogo, and GoFundMe provide a forum for persons seeking funds (i.e. project initiators) to present their project or products in order to attract potential contributors, referred to as ‘backers.’ Project initiators may offer contributors rewards of nominal value, such as T-shirts, in exchange for a contribution, while others may offer sample products or rewards based on the level of contribution.
Campaigns can be set up with a fixed funding goal where the project initiator receives contributions only if funding goals are met, or with flexible funding goals that allow the initiators to keep funds even if the funding goal is not met. The websites charge initiators a fee per transaction; fixed funding goal campaigns are charged a lower fee.
Contributions are made via credit cards, so the crowdfunding websites often use financial intermediaries like PayPal or Amazon Payment to track the credit-card transactions. If more than 200 separate transactions worth more than $20,000 are generated by a campaign, the intermediary has to file a Form 1099-K to report the proceeds. Though a 1099-K is not required in many cases, this does not mean that the funds received are excludable from the recipient’s taxable income.
Tax Treatment of Crowdfunding Revenues
Under general income-tax principles, gross income is broadly defined to include income from all sources. Only items specifically exempt can be excluded from income. Based on these principles, most crowdfunding revenues will be includible in the recipient’s gross income unless he or she can show that the funds are excludible as: (1) contributions to capital in exchange for an equity interest in the entity, (2) loans that must be repaid, or (3) gifts made with donative intent where the donor does not receive a tangible economic benefit in return for his contribution.
Proceeds from donation-based campaigns may qualify as non-taxable gifts if the funds are for the benefit of an individual or a public charity, depending on the purpose and intent of the payment. For instance, if a campaign is to help an individual with unanticipated medical bills due to a tragedy, then the contributions might qualify as a gift. Where a gift exceeds the annual gift-tax exclusion of $14,000 (2016 exclusion amount), the donor may have a gift-tax filing responsibility.
Whether the proceeds from a reward-based campaign should be included in the recipient’s gross income is more difficult to determine because the value of the ‘reward’ must be determined. Crowdfunding often involves the project initiator providing a new product to the contributor in exchange for their ‘contribution.’ If the reward given to the contributor equals or exceeds the amount of the pledge, then the full payment is considered gross income to the recipient.
In essence, the contributor has paid for the reward, and there is no donative intent. Where the value of the reward is less than the ‘contribution,’ then the difference between the contribution and the value of the reward must be evaluated to determine whether it qualifies as a gift or some other type of contribution. In this situation, only a portion of the payment received by the recipient may be characterized as gross income.
Newer to the crowdfunding scene are equity-based campaigns, where crowdfund contributors are provided with an ownership stake in a startup venture in exchange for their contribution. These payments are a contribution to capital and are not gross income to the startup entity. However, there may be tax implications to the investor depending on the valuation of the interest, which is beyond the scope of this article.
Tax Treatment of Crowdfunding Expenditures
Once it has been determined that crowdfunding revenues should be included in federal gross income, the project initiator must determine what expenses, if any, are deductible. A detemination must be made whether the activity is a trade or business or a hobby. Distinguishing between the two is based on a fact-and-circumstances determination that looks to a series of nine factors.
In addition, the timing of when crowdfunding expenditures may be deducted can be an issue. The crowdfunding activity must be considered an active trade or business for the expenses to be eligible for deduction.
Tax Treatment of Contributions to Crowdfunding Campaigns
The tax treatment of a contribution made by a backer to a crowdfunding campaign depends on the motive of the backer as well as whether he or she receives anything in exchange for the payment. If the backer is making a campaign contribution out of disinterested generosity and does not receive anything in return, he has most likely made a gift. Only if the gift is to an approved public charity will it be deductible as a charitable contribution. A gift to a private individual seeking funds is not going to qualify as a charitable contribution even though it may be to help defray medical costs.
Contributions made to a campaign where the contributor receives goods or services of equivalent value in return are not tax-deductible. If a backer wants to make a significant contribution to a cause or project, it may be worth consulting with an advisor as to whether there are more beneficial or efficient ways to provide support.
Other Tax Issues
State and local taxes as well as sales and use taxes are other areas of concern for crowdfunding campaigns. Advance consideration should also be given to the most beneficial accounting method and best form of doing business for project initiators in a startup trade or business. Proper planning before entering into a crowdfunding campaign can help avoid undesirable tax consequences and surprises to project initiators.