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Tax Consequences of Crowdfunding
Article Highlights:
Crowdfunding Sites
Gifts
Charitable Gifts
Business Ventures
SEC Registration
Crowdfunding Scams
Raising money through Internet crowdfunding sites prompts questions about the taxability of the money raised. Several sites host money-raising projects for fees generally ranging from 5 to 9%, including GoFundMe, Kickstarter, and Indiegogo. Each site specifies its own charges, limitations, and withdrawal processes. The money raised may or may not be taxable depending on what the purpose of the fundraising campaign was.
Gifts – When an entity raises funds for its own benefit and the contributions are made out of detached generosity (and not because of any moral or legal duty or the incentive of anticipated economic benefit), the contributions are considered tax-free gifts to the recipient.
On the other hand, the contributor is subject to the gift tax rules if they contribute more than $17,000 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. Please note the $17,000 amount is inflation adjusted and was $15,000 for years 2018 through 2021 and $16,000 for 2022. Please contact this office for any other year.
A “gift tax trap“ occurs when an individual establishes a crowdfunding account to help someone else in need (the beneficiary) and takes possession of the funds before passing the money on 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 then treated as a gift from the fundraiser to the beneficiary; if the amount is over $17,000, the fundraiser is required to file a gift tax return and reduce their lifetime gift and estate tax exemption. Some crowdfunding sites allow fundraisers to designate a beneficiary to have direct access to the funds, in which case the fundraiser avoids encountering any gift tax problems.
Gifts to specific individuals, regardless of need, are not considered charitable contributions under tax law—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, but if the recipient itemizes their deductions, any amount of the gift the recipient spends to pay for their (or a spouse’s or dependent’s) medical expenses can be included as a medical expense when the recipient is itemizing deductions on Schedule A of their individual tax return.
Charitable Gifts – Even if the funds are being raised for a qualified charity, the contributors cannot deduct the donations as charitable contributions without proper documentation. Taxpayers cannot deduct cash contributions (including payments by check, credit card, or made electronically), regardless of the amount, unless they can document the contributions in one of the following ways:
Contribution Less Than $250: To claim a deduction for a contribution to a qualified charitable organization of 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 or more, the taxpayer must have a written acknowledgment of the contribution from the qualified organization. This acknowledgment must be in the donor’s hands before the earlier of the due date or the date the return for the year the contribution was made is filed, including extensions, and must include the following details:
o The amount of cash contributed;
o Whether the qualified organization gave the taxpayer goods or services (other than certain token items and membership benefits) as a result of the contribution, along with a description and good-faith estimate of the value of those goods or services (other than intangible religious benefits); and
o A statement that the only benefit received was an intangible religious benefit, if that was the case. Thus, if the contributor is to claim a charitable deduction for a cash donation made through a crowdfunding campaign, the contributor must have some way of obtaining a receipt.
Business Ventures – When raising money for business projects, there are two issues to contend with: the taxability of the money raised and the U.S. Securities and Exchange Commission (SEC) regulations that come into play 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, such as 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 or a partnership interest. In this circumstance, the money raised is treated as a capital contribution and 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, which generally require any such offering to be registered with the SEC. However, the SEC regulations carve out a special exemption for crowdfunding:
o Fundraising Maximum – The maximum amount a business can raise without registering its offering with the SEC is $5 million in a 12-month period. Non-U.S. companies, businesses without business plans, firms that report under the Exchange Act, certain investment companies, and companies that have failed to meet their reporting responsibilities may not participate.
o Contributor Maximum – The SEC also limits the amount investors contribute. The amount an individual can invest through crowdfunding in any 12-month period is limited:
- If the individual’s annual income or net worth is less than $124,000, their equity investment through crowdfunding is limited to the greater of either $2,500 or 5% of the greater of the investor’s annual net worth.
- If the individual’s annual income and net worth is at least $124,000, their investment via crowdfunding can be up to 10% of their annual income or net worth, whichever is greater, but not to exceed $124,000.
- The forgoing limits are based on the SEC Updated Investor Bulletin posted on October 14, 2022. These limits change from time to time. The bulletin also includes examples of limits, included above, are computed as well as instructions for determining net worth.
On the bright side, even if the money raised is income to the business, it will probably net out to zero taxable if it is spent on tax-deductible business expenses.
Does the IRS Track Crowdfunding? – Maybe. It depends on the aggregate number of backers contributing to the fundraising campaign and the total amount of funds processed through third-party transaction companies (credit card, PayPal, etc.). These third-party processers are required to issue a Form 1099-K reporting the gross amount of such transactions. There is a de minimis reporting threshold of $600 or per year beginning in 2023. The question is, will the third party follow the de minimis rule?
Be Cautious to Avoid Crowdfunding Scams – Keep in mind that the project or campaign you are considering backing 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 and 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.
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