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Archives for October 2020

Crowdfunding

October 15, 2020 by Dana Lee CPA LLC Team

Crowdfunding — or funding a project through the online contributions of many different backers — is becoming increasingly popular. If you are considering raising crowdfunding revenue or contributing to a crowdfunding campaign, you will need to address the many tax issues that can arise.

Background

Crowdfunding was initially an instrument that some used in order to raise money for projects that were unlikely to turn a profit. But others have begun to see crowdfunding as an alternative to venture capital. Depending on the project, those who contribute may receive nothing of value, a reward of nominal value (such as a T-shirt or tickets to an event), or perhaps even an ownership/equity interest in the enterprise.

Is It Income?

In an “information letter” released in 2016, the IRS stated that crowdfunding revenues will generally represent income unless they are:

  • Loans that you must repay
  • Capital contributed to an entity in exchange for an equity interest in the entity
  • Gifts made out of detached generosity without any “quid pro quo”

The IRS noted that the facts and circumstances of each case will determine how the revenue is to be characterized. The IRS added that “crowdfunding revenues must generally be included in income to the extent they are for services rendered or are gains from the sale of property.” In addition, the IRS warns that a voluntary transfer without a “quid pro quo” is not necessarily a gift for federal income tax purposes.

Frequently, the IRS learns of the activity because crowdfunding entrepreneurs have used a third-party payment network to process the contributions. Where transactions during the year exceed a specific threshold — gross payments in excess of $20,000 and more than 200 transactions — that third part will send Form 1099-K (Payment Card and Third-Party Network Transactions) to the recipient and the IRS. Payments that do not meet the threshold are still potentially taxable.

If It’s Business Income

You can deduct “ordinary and necessary” business expenses. But you might have limitations in how much you can deduct if the IRS deems the activity a hobby rather than a trade or business. Generally, the IRS applies a “facts and circumstances” test to determine if you have a profit-making motive, which is necessary for a trade or business.

New Businesses

You can use favorable deduction rules for certain types of expenses you incurred in starting a new business. If eligible, the business may elect to expense up to $5,000 of those costs (subject to phaseout) in the year the business becomes active. The remainder of the start-up expenditures are deducted ratably over a 180-month period.

For Contributors

Campaign contributors should not assume that their gifts qualify as tax-deductible charitable contributions. Tax-deductible contributions must meet certain requirements. The contributors must make their contributions to a qualified charitable organization. If you make a gift to an individual or nonqualified organization, you might need to file a gift tax return. You have this reporting for gifts to any one recipient that exceed the gift tax annual exclusion ($15,000 for 2020).

There is no definite guidance specific to crowdfunding in the tax regulations. One must analyze each case on an individual basis in order to determine the potential tax implications. You might also consider requesting a private letter ruling from the Internal Revenue Service.

If you need help with your taxes, give us a call.

This material is for informational purposes only. It does not constitute tax, legal or accounting advice.

Filed Under: Tax Regulations

Be Aware of the Family Loan Tax Rules

October 1, 2020 by Dana Lee CPA LLC Team

Obtaining financing to start or expand small businesses and buy homes can sometimes be difficult. Your family member might have a hard time getting a loan from a commercial lender. You may want to help out with a family loan.

Have a Written Agreement

Start by putting the family loan agreement in writing. This may seem like an unnecessary formality. But without a written loan document, the IRS could argue that the transaction was a gift instead of a loan. This can create potential gift tax issues. Having written documentation is also important in case the borrower fails to repay all or part of the loan.

Charge Adequate Interest For a Family Loan

The second step is setting an interest rate. While there’s no rule against interest-free loans or loans that have below-market interest rates, in a family context they can lead to tax complications. If you don’t charge sufficient interest, the difference between the amount of interest you actually receive (if any) and the amount you should have received — referred to as “imputed” interest — is taxable to you.

You can avoid the imputed interest rules by charging interest at the appropriate “applicable federal rate” (AFR) for the loan term that applies to you. Short-term AFR applies to three or fewer years loan terms, mid-term AFR applies to loan terms of more than three years, but no more than nine years and long-term AFR applies to loans of over nine years. The IRS publishes AFRs monthly for loans of different maturities. These rates have been relatively low recently, reflecting the current market interest rate environment. To see the IRS AFRs, click here.

For a term loan, the rate can remain fixed for the life of the loan. A demand loan has different requirements. A demand loan is one that gives you the right to demand full repayment at any time. For such a loan, you have to charge a floating AFR to avoid imputed interest issues.

Exceptions

When you lend a family member no more than $100,000, the amount that can be added to your taxable interest income under the below-market interest rate rules generally can’t exceed the borrower’s net investment income. Even better, you won’t have to report any imputed interest if the borrower’s net investment income amounts to $1,000 or less. You can also sidestep imputed interest on small loans of no more than $10,000 (all outstanding principal) provided the borrowed funds aren’t used to buy or carry income-producing assets.

You can find out more information about the treatment of loans with below-market interest rates here.

If you need help with your small business, give us a call.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice.

Filed Under: Tax Regulations

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