Understanding Crowdfunding Taxes
We are NOT Responsible for Your Tax Documentation
You should assume in general that your donations are not tax-deductible.
If you are donating to a charity, you can request a receipt from that charity directly. The charity may or may not send you a receipt that you can use for your tax returns since each charity operates differently. Therefore, it is your sole responsibility to get the proper documentation, if you feel that your donation to a charity might be tax deductible. Fund by Cell does not work directly with charities to provide any of these documents.
Understanding how taxes apply to money raised through crowdfunding can be difficult. Crowdfunding is a relatively new phenomenon, so there are no cut and dried laws regarding crowdfunded money.
One thing is clear, however, other than the fees they collect, crowdfunding companies and platforms are not responsible for the money you raise through their service, the person crowdfunding is. So, it is important to be cautious and to do your research if you have received money through crowdfunding, especially with April 15th just around the corner.
There are four taxable ways money raised in crowdfunding can be categorized: Sales Tax, Income Tax, Equity, or Gifts.
Most crowdfunders do not think of the money raised during their campaign as sales, but given a closer look, much of crowdfunding is pre-selling. If a backer contributes money and in return receives a salable product (CD, DVD, iPhone case, etc.), the money received is from a type of sales, and thus, is susceptible to sales tax. Understand how you gave your prizes to your backers, and then decide whether the funds you raised could be seen as sales by the IRS.
The most likely category that crowdfunding money will be put in is the income category. Since the crowdfunder is earning money for a product or service, which the backer is receiving, the money will usually be labeled as income. This is the most common category that crowdfunding money falls under. It is often seen as the most fitting category, and you have to remember that money is likely not exempt from income tax. However, there may be exceptions for colleges and nonprofits using crowdfunding, so it is best to ask an expert when unsure.
Having funds fall into the equity category is still on hold in the United States. For the latest news on the issue check out this article. If you are outside the US, explore this info-graphic on one successful investment based platform in the UK.
Gift is the most appealing category to have crowdfunding money be labeled under. Section 118 and 102 of the Internal Revenue Code excludes gifts from taxable income, so wanting the money from your crowdfunding campaigns to be labeled as a gift is understandable. However, since prizes are often offered in exchange for a backer’s contribution, the money will not likely be valid gifts. For more details on gifts check out this article.
The most important part of crowdfunding and taxes to remember is to be careful! Taxes are tricky, complicated, and often foreign to non-experts. No one wants an audit or the IRS going after them, so it is best to play it safe when it comes to crowdfunding money. But, if you want your crowdfunded money to be considered tax exempt, be sure to consult a professional.
If you’re thinking about jumpstarting your own cause, an innovative new product or a future small business, you’ll need capital — or access to it.
For many, the answer has been crowdfunding, a fast-growing, web-based system of raising funds from individuals around the world. It’s an industry less than a decade old that allows artists, activists and a growing number of entrepreneurs to connect with financial support far outside the conventional lending system. Currently, Kickstarter, Indiegogo and RocketHub are leading the industry. Estimates vary widely, but research organization Massolution put 2013 global crowdfunding revenue at $5.1 billion.
Here’s how crowdfunding works. Through sites like the ones mentioned above, campaigners seeking a sum of money to get a project off the ground create a pitch that educates potential funders — or “backers,” as they’re often called — on their project, its funding goal and the reward backers will receive for taking part. If interested, backers use their credit card to make a pledge. If the campaign meets its goal and deadline, the crowdfunding site activates all the card-based pledges and the campaign is funded.
Many crowdfunding efforts today are artistic or cause-based, but that is expected to change in the near future. Implementing the crowdfunding provisions of 2012’s Jumpstart Our Business Startups (JOBS) Act, the U.S. Securities and Exchange Commission is putting final touches on regulations allowing ordinary investors to participate in equity crowdfunding for the first time. This would mean that business owners could raise money via the web in exchange for a piece of ownership in their company.
Because the process of crowdfunding is relatively easy compared to other means of obtaining capital, some might neglect to research potentially unfavorable tax, financial or legal implications from their campaign. Potential crowdfunding campaigners might want to make a preliminary call to a qualified tax adviser, financial planner or an attorney before launching any online fundraising effort.
No matter how the crowdfunding industry evolves in the future, even the most modest artistic and cause-based campaigns should consider how to build the most tax-efficient effort. It comes down to a central question: will your campaign’s proceeds be deemed non-taxable gifts or taxable income?
In crowdfunding, campaigners typically offer a “reward” that is typically well below the value of what the backer gives. Some campaigns go with an online thank-you, t-shirts, hats or an exclusive first run of their product or service. Rewards are typically offered on a tiered basis, meaning backers will be offered something cooler and more valuable for higher contributions.
Many experts believe the whole crowdfunding tax landscape needs more clarification, possibly through a test case in the federal court system. That is why both campaigners and backers might consider getting advance tax, financial or legal advice that directly addresses their personal circumstances. Another important reason to seek advice; many states have their own tax laws that may affect funding campaigns.
Back to the non-taxable gift vs. taxable income issue. The IRS says a gift in general is “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.” One example of a non-taxable gift is what’s commonly known as the annual exclusion. In 2015, an individual can offer a non-taxable gift of up to $14,000 in 2015; spouses can give a combined $28,000.
Taxable income issues can be significantly more complex. Campaigners should be aware that crowdfunding sites often use financial intermediaries to keep track of all backer transactions, including tax-reporting issues. As an example, if a campaign reports over 200 separate transactions worth more than $20,000, the intermediary generally has to issue an IRS form 1099-K. Even if a crowdfunding campaign raises considerably less than that amount, it doesn’t guarantee there won’t be tax issues later.
All of these factors make qualified and individualized tax, legal and business advice valuable. Consider adding the following to your list of questions if you do:
How can crowdfunding proceeds affect the campaigner’s current tax status? Individuals, companies and nonprofits have different tax issues and financial precedents that could blunt the effectiveness of any fundraising campaign. Again, it is wise to do tax and implementation planning for a crowdfunding campaign before launch so all potential issues can be addressed.
What tax issues might affect the beneficiaries? Crowdfunding a person’s unpaid medical bills may have significantly different tax ramifications than crowdfunding one’s own independent film project. It is not enough to consider the tax ramifications for the campaign; if there are separate beneficiaries, their tax issues may dictate a different approach to raising funds.
Should a business or nonprofit entity be formed in advance? Sometimes fundraising plans spawn bigger questions about the long-term goals of the individual, group or enterprise. If appropriate, participants could seek guidance to form an actual business or nonprofit entity. Discussing structural issues in advance will not only help with tax issues, but also lead to better strategies for fundraising and long-term mission.
Is it wise to become a backer? Most crowdfunding supporters give such small amounts that tax issues don’t really surface. But backers who want to offer more substantial support should speak with financial advisers about whether there are more efficient ways to lend support.
Bottom line: Before you consider crowdfunding a cause, project or business, it’s important to do individual research and consider speaking with qualified financial advisers. This exciting, fast-growing alternate funding system may have unexpected tax consequences for individuals, groups and backers.
Crowdfunding has grown into a prominent internet-based vehicle for raising money from a large number of people who may have little in common other than a desire to contribute to the success of the project or other endeavor. On websites such as kickstarter.com and indiegogo.com, “creators” or initiators of a fundraising campaign seek contributors, or “backers,” to finance their projects. Other sites, such as gofundme.com or causes.com, feature fundraisers for personal or charitable endeavors.
Thousands of businesses and individuals have succeeded in attracting funding through these sites, but often with little thought to the ramifications for income taxes. 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. Consequently, there are few, if any, definitive guidelines, especially in view of the variety of types of arrangements and transactions that crowdfunding has taken so far, with still more options likely to come. Still, applying common tax principles and common sense may help tax preparers and advisers in talking through the issues with their clients who have taxable crowdfunding income and deciding how to report and pay taxes on it. This article provides some points to cover and related considerations.
TYPES OF CROWDFUNDING
Crowdfunding in the United States falls into three distinct types: for creative enterprises, which can be characterized as reward-based crowdfunding; as a means of personal fundraising, or donation-based crowdfunding; and equity-based crowdfunding, which raises capital for companies and for which the SEC issued final rules earlier this year. All three types are gaining in popularity and are frequently promoted on social media outlets such as Facebook and Twitter.
Reward- and donation-based crowdfunding use third-party payment processing for collecting money. Both PayPal and Amazon Payments provide these services for crowdfunders. Each service has slightly different rules, but both comply with the U.S. Patriot Act data-collection requirements, and both work with the IRS. A campaign creator who collects over $20,000 and has 200 transactions in a year will receive a Form 1099-K, Payment Card and Third Party Network Transactions, reporting unadjusted gross revenues.
While pledges received from donation-based crowdfunding are likely to be considered nontaxable gifts, reward-based crowdfunding is likely to carry income tax ramifications for the project creator. Those tax consequences are the focus of this article.
INCOME TAX CONSEQUENCES
Kickstarter states that it cannot give tax advice but indicates that in the United States, funds raised through campaigns on Kickstarter will generally be considered income (see “Kickstarter and Taxes: A Guide for Your Accountant,” available at kickstarter.com. The site suggests that expenses may be deductible against the income. It also says that some of the amounts raised may be nontaxable gifts but does not explain the distinction other than to give a partial definition of a gift for tax purposes.
The Internal Revenue Code and IRS guidance do not address crowdfunding, leaving several possibilities for how it should be treated for tax purposes. Accordingly, the following should not be regarded as a definitive guide but only as considerations in exploring each taxpayer’s situation to assess possible tax treatments and, hopefully, settle on a well-reasoned and substantiated position. Also, note that crowdfunded activities may be subject to other taxes, notably, sales and use taxes. See “Tax Clinic: Crowdfunding Contributions and State Sales and Use Taxes,” The Tax Adviser, June 2015, page 420.
Amounts received through reward-based crowdfunding campaigns most likely are taxable income under Sec. 61, to be reported by the creator in the year of receipt. While not determinative of federal income tax, Washington state guidance indicates crowdfunding income may be subject to state excise, sales, and/or business and occupation tax (Tax Topics, available at dor.wa.gov. In August 2013, the Canadian Revenue Authority interpreted Canadian tax law as generally requiring inclusion of reward-based crowdfunding in Canadian taxable income where receipts are “by virtue of a profession or … carrying on a business” (available at taxinterpretations.com. If, by analogy, tax practitioners conclude that a client’s crowdfunding income is includible in U.S. federal gross income, a number of other questions and issues arise, including what expenses, if any, should be deductible against it. That depends on several factors, including:
Whether the crowdfunding activity is deemed a trade or business or a hobby;
Whether the activity is deemed a startup business;
The method of accounting used by the creator; and
The value of rewards given to backers.
TRADE OR BUSINESS VS. HOBBY
If the activity is deemed a trade or business, all otherwise allowable trade or business expenses should be deductible against the income (Sec. 62). If, however, the activity is deemed to be a hobby, only expenses to the extent of the income will be deductible (Sec. 183).
Whether an activity is a trade or business or a hobby is a facts-and-circumstances determination. The Sec. 183 limit can apply to individuals, partnerships, S corporations, estates, and trusts; it does not apply to C corporations. Nine factors are generally considered when making this determination, including whether the business is run in a businesslike fashion, whether the owner had any experience or knowledge in the business area, and whether the activity is carried on for recreation or personal purposes. See “Tax Practice Corner: Business or Hobby? The Nine Factors,” JofA, Oct. 2013, page 71, for a discussion of these factors and their application.
STARTUP TRADE OR BUSINESS
If the crowdfunding activity is a new business, creators may have startup costs or, in the case of an activity set up as a corporation or partnership, organizational costs.
A taxpayer must capitalize these costs unless the taxpayer makes an election under Sec. 195 for startup costs or Sec. 248 (corporations) or Sec. 709 (partnerships) for organizational costs to deduct up to $5,000 of these costs (reduced by the amount by which they exceed $50,000). The deduction is taken in the year the trade or business becomes active (for startup costs) or the partnership or corporation begins business (for organizational expenses), and the remainder of the startup costs are amortized over a 15-year period beginning in the month in which the trade or business becomes active or the corporation or partnership begins business. A taxpayer is deemed to make the election to deduct and amortize these expenses unless it affirmatively elects to capitalize them on the return in which the trade or business activity begins or the entity begins business.
For startup or organization costs to be deducted at all, the activity must be considered an active business. Court decisions on when a taxpayer becomes engaged in an active trade or business have focused on when the business becomes a “going concern” or when it begins to perform a specific business operation and produce the product or service for which it was formed. Generally, this depends on the facts and circumstances—but conducting a crowdfunding activity alone may not be considered engaging in an active business, so crowdfunding expenses may not be deductible until a later year, when the business begins its active business.
ACCOUNTING METHOD: TIMING OF INCOME AND EXPENSES
Both Kickstarter and Indiegogo warn backers that the websites do not guarantee the completion of the project or the delivery of the reward. This means that once creators receive the funds, they have complete control over them, even if they do not complete the project and deliver the reward. Based on the claim-of-right doctrine, this income is taxable in the year of receipt regardless of the creator’s accounting method.
Creators can have a timing problem, however, if the income is taxable in one year but the related expenses, which usually would be incurred after completion of a campaign, are not deductible until the following year. This can create cash flow problems for the creator that could affect the creator’s ability to complete the project. Creators can plan to end their campaigns early in the year so some, if not all, of the expenses of their project will be incurred during the same year.
VALUE OF REWARD GIVEN TO BACKERS
The discussion above presupposes that the backer receives something of value in exchange for a contribution to a campaign. Some of the rewards offered on the crowdfunding campaigns, however, might be difficult to value. For example, a CrowdPress project that developed a “playhouse” for cats offered not only a set of blocks to build the structure but, at lesser levels of funding, a picture of cats with the backer’s name and lifetime entry to the creator’s office in Amsterdam to “cuddle” with cats there.
If the value of any of the rewards offered cannot be determined, or if a reward is determined to have no value or a value less than the pledge amount, additional evaluation may be required to determine whether all or part of the contribution can be classified as a nontaxable gift or some other type of contribution.
On its “Guide for Your Accountant” webpage mentioned above, Kickstarter indicates that certain funds raised through a crowdfunding campaign might be classified as a nontaxable gift (Sec. 102). A gift is generally defined for federal income taxes as an amount transferred out of “detached and disinterested generosity” (Duberstein, 363 U.S. 278 (1960)). Gift treatment would be disallowed where the reward has a value approximately equal to or greater than the contribution in return for the payment (American Bar Endowment, 477 U.S. 105 (1986)).
Therefore, amounts received as a reward-based crowdfunding campaign that promises a reward that has some value is unlikely to be considered a gift. Contributions from backers who choose to forgo the reward might be treated as nontaxable gifts, but the exact circumstances of the contributions must be considered.
In the case of corporations, Sec. 118 allows certain receipts to be treated as nontaxable contributions to capital by a non-shareholder. This is unlikely to apply to most reward-based crowdfunding, as most creators do not operate their campaigns through corporations.
If, however, the creator operates the activity as a corporation and the backer receives no reward, certain requirements must be met for the contribution to be treated as a nonshareholder contribution to capital. In Chicago, Burlington & Quincy R.R. Co., 412 U.S. 401 (1973), the Supreme Court required that the contribution meet five factors: (1) The asset must become a permanent part of the transferee’s working capital structure, (2) may not be compensation for services rendered (or presumably for products received), (3) must benefit the transferee commensurately with its value, (4) ordinarily will be used to produce additional income, and (5) must be bargained for. While a crowdfunding contribution may meet some of the criteria, the last factor will likely prove problematic. Due to the nature of a crowdfunding campaign, creators simply post a project and hope backers will choose to contribute. Kickstarter will not provide backer information to a creator until after a project is funded and contributions are received by the creator, so negotiation is not possible.
SUPPORT AND GUIDANCE STILL UNCLEAR
While crowdfunding is becoming more common, tax support and guidance for campaign creators remain unclear on many points. At a minimum, the treatment of funds generated through crowdfunding depends on the method of fundraising and the value of any reward offered. Once these are established, it appears likely many creators will be considered to operate a trade or business, with attendant issues of method of accounting. These could entail tax treatment of startup expenses, along with some potential problems of timing of income and expense recognition peculiar to the funding scheme that could cause unexpected difficulties for creators in fulfilling rewards.
— The End —