Crowdfunding contributions are often thought of as “free money,” but that’s not the case, and failure to comply with tax laws could cause issues with the IRS.
Crowdfunding sites like Kickstarter and Indiegogo have provided an unprecedented avenue for people to get funding for their creative projects, to recover from an unexpected setback or even to launch their own independent business. But the donations aren’t just free money. Depending on what you’re raising money for, there could be important tax implications to consider before you cash out those funds.
Charitable Donations and Gifts
Many crowdfunding campaigns source funding for medical expenses or charitable causes. In those cases, the money does not need to be reported to the IRS. Those funds are considered charitable donations or gifts.
Even small businesses can classify money received through crowdfunding as a gift. Those who donate to the campaign don’t receive any sort of stock, and they don’t expect repayment like with a small business loan. They are making a contribution on their own volition, without expectation of repayment. In these cases, the IRS has a gift tax rule. The donor ends up paying the gift tax, not the crowdfunding beneficiary.
A gift is, according to the IRS, “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.” Reuters sums this up as “money received without an offsetting liability (such as a repayment obligation), that is neither a capital contribution to an entity in exchange for a capital interest in the entity nor a gift, is includible in income. The facts and circumstances of a particular situation must be considered to determine whether the money received in that situation is income.”
Loans and capital contributed in exchange for equity are not considered gifts.
Taxable Crowdfunding Income
Often in crowdfunding campaigns, donors do receive something as an incentive for contributing, whether it’s company merchandise, a gift card or something larger. As soon as the contributor receives an item of any value, the contribution is taxable. If a crowdfunding campaign is set up so that a contributor receives a gift card or merchandise in exchange for donated money, it’s viewed as a business transaction.
Crowdfunding campaigns are no longer just for individuals looking to fund their next creative project. Businesses are starting to use them, too. The Jumpstart Our Business Startups Act (JOBS Act), set up by the U.S. Securities and Exchange Commission in 2012, put regulations in place so that investors could start equity crowdfunding. The act allows business owners to raise money online in exchange for ownership of the company, like traditional investing but via a simple platform.
Don’t Get Caught Cheating the Crowdfunding System by the IRS
If this sounds confusing, don’t worry. Experienced attorneys can help you navigate whether your crowdfunding contributions are taxable and how to report that income to the IRS, based on where you live. Perhaps the product or service you’re giving in exchange for funding isn’t taxable in your state. Or maybe you aren’t required to collect sales tax for online purchases by out-of-state residents, but are required to collect for in-state residents. Federal, state and sales tax all have different laws, which can make a simple crowdfunding idea suddenly complicated.
If you don’t report your income, it could be reported for you. Many crowdfunding sites keep track of larger transactions. If someone receives more than $20,000, the crowdfunding site has to issue an IRS form 1099-K, a form used for third-party transactions. If you receive one of these forms, you have to report it on your tax returns. If you don’t receive one of these forms, it doesn’t mean you’re off the hook for income less than $20,000. Talk to an attorney about when, and in which situations, you need to start reporting this income.
Financial precedents and tax issues could hurt the effectiveness of crowdfunding campaigns, so before you get started, talk with a lawyer to make sure it’s the best route for raising money. The attorneys at Anselmo Lindberg & Associates can help you figure out which crowdfunding tax laws apply to your campaign, and how to stay in the good graces of the IRS. Contact us today.