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.
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.
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.
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.