Tax Consequences of Crowdfunding

In recent years, crowdfunding to raise capital on sites like Indiegogo or GoFundMe has become a popular way to raise funds for creative, entrepreneurial, or even charitable endeavors. These funds are being raised to help new businesses get up and running, to launch creative projects, and even to fund special needs trusts. Often, the businesses or individuals setting up these crowdfunding campaigns put little or no thought into the tax ramifications of taking in funds this way. Their focus is purely on raising money – until tax time.

At this time, congress and the IRS haven’t addressed crowdfunding income and if, how, or when that income should be taxed. Instead, tax lawyers and CPAs rely on common tax and accounting principles when helping their clients navigate the taxability question. Because there is no clear guidance on these issues, getting the help of a tax lawyer or CPA is often the best route to ensure that everything is reported correctly. Below is a brief discussion of some of tax questions posed by crowdfunding and a summary of some of the analysis that a tax lawyer or CPA would do when faced with a crowdfunding question.

Types of Crowdfunding

There are three types of crowdfunding that we commonly see:

  • reward-based crowdfunding – when the contributors get something in exchange for their contribution, for example a pre-order of a product
  • donation-based crowdfunding – soliciting donations for a personal or charitable cause, such as payment of medical bills
  • equity-based crowdfunding – raising capital by offering some shares of the business in exchange for contributions

Amounts received from donation-based crowdfunding are generally considered non-taxable gifts as long as they are below the annual gift tax exclusion amount ($14,000 in 2016). A gift is generally defined for federal income tax purposes as an amount transferred out of "detached and disinterested generosity" (Duberstein, 363 U.S. 278 (1960)). This means that if the contributor received anything in exchange for his contribution, as is the case with most reward-based crowdfunding, it would not be considered a gift and would not be tax-free even if it was less than the annual gift tax exclusion amount.

Income Tax Consequences for Reward-Based Crowdfunding

Amounts received through reward-based crowdfunding campaigns are usually taxable as income under 26 USC § 61. If the amounts received are taxable income, then are there any deductions that can be taken against that income? That depends on a number of factors:

  • Is the crowdfunding activity a trade or business, or a hobby?
  • If it’s a business activity, are the funds being used for the business startup?
  • What is the method of accounting that the campaign originator uses?
  • What is the value of the reward that is given to contributors?

If the activity is deemed a trade or business, all otherwise allowable trade or business expenses should be deductible against the income under 26 USC § 62. But if the activity is a hobby, only expenses to the extent of the income will be deductible under the hobby loss rules (26 USC § 183). Many crowdfunding projects skirt the line between business and hobby. Whether an activity is a business or a hobby is fact specific and should be addressed with a CPA or tax lawyer.

In talking about reward-based crowdfunding, we have assumed that the contributor receives something of value in exchange for his contribution to a campaign – this is what differentiates it from donation-based crowdfunding. But some of the rewards offered as part of crowdfunding campaigns are difficult to value. For example, a Kickstarter project that was raising money to buy a new theatre for an acting troupe offered to tweet Shakespearean insults at a person of the contributor’s choosing in exchange for a $50 contribution. What is the value there? Not sure. If the value of a reward can’t be determined, or if a reward is determined to have no value or a value less than the contribution amount, then the proper tax treatment is less clear.

Because the IRS hasn’t addressed these issues, there isn’t a clear guide for what is taxable and when. With the help of a CPA or tax lawyer, you should be able to come to a well-reasoned position. If you did crowd funding in 2015 and need help determining how to treat those funds, or if you did crowd funding in a previous year and are worried that you didn’t treat the income correctly, give us a shout. We’re happy to talk about your facts and advise you on the best way to handle your situation.