Income Tax Treatment of Crowdfunding Income
The IRS has specific rules that govern the income tax treatment of crowdfunding income. Whether you plan to back crowdfunding projects as an individual OR your company intends to use a crowdfunding platform for fundraising, it is important to understand the tax implications.
Section 61(a) of the Internal Revenue Code provides the general rule that, except as otherwise provided by law, gross income includes all income from whatever source derived. Gross income includes all accessions to wealth, whether realized in the form of cash, property or other economic benefit. However, some benefits that a taxpayer receives are excludable from income, either because they do not meet the definition of gross income or because the law provides a specific exclusion for certain benefits that Congress chooses not to tax.
In general, 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.
What that means is that crowdfunding revenues generally are includible in income if they are not
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Loans that must be repaid,
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Capital contributed to an entity in exchange for an equity interest in the entity, or,
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Gifts made from detached generosity and without any “quid pro quo.” However, a voluntary transfer without a “quid pro quo” is not necessarily a gift for federal income tax purposes. In addition, crowdfunding revenues must generally be included in income to the extent they are received for services rendered or are gains from the sale of property.
Reg. Sec. 1.451-2 sets forth the constructive receipt doctrine and provides that income, although not actually reduced to a taxpayer's possession, is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. The regulation further provides that income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions. However, a self-imposed restriction on the availability of income does not legally defer recognition of that income.
Thus, the income tax consequences to a taxpayer of a crowdfunding effort depend on all the facts and circumstances surrounding that effort.
A taxpayer may request a private letter ruling from the Internal Revenue Service, for a fee, that applies the law to the taxpayer’s particular facts and circumstances. The procedure for obtaining a private letter ruling is set forth in Rev. Proc. 2022-1, I.R.B. 2022-1.
Does the IRS Track Crowdfunding Payments?
Code Sec. 6050W requires third party transaction companies (credit card, PayPal, etc.) to issue a 1099-K reporting the gross amount of such transactions if a specified threshold is exceeded.
Effective for 1099-Ks required to be filed for calendar years that begin after December 31, 2022, the reporting threshold is $600 (previously the threshold was $20,000 or 200 reportable transactions) (ARPA Sec 9674, amending IRC Sec 6050W(e)); effective date postponed by IR-2022-226. A Fact Sheet (FS 2022-20) posted in March 2022 by the IRS to their website clarifies that, if a crowdfunding website or its payment processor meets the reporting threshold for a 1099-K, it will need to issue 1099-Ks to the IRS and the crowdfunding contributors unless the contributors to the crowdfunding campaign did not receive goods or services for their contributions. See more about 1099-Ks in Chapter 3.00.
Is the Income Received by the Fundraiser Taxable or is it a Tax-Free Gift?
It depends. Code Sec. 61(a)(1) defines gross income as "all income from whatever source derived." This definition is construed broadly and unless the taxpayer can demonstrate that the income fits into one of the exclusions provided by law it will be taxable. One of those exceptions is provided in Code Sec. 102, where the amount received is a gift if it: comes from a detached and disinterested generosity; is made out of affection, respect, admiration, charity or like impulses; is not made from any moral or legal duty, nor from the incentive of anticipated benefit of an economic nature; and is not in return for services rendered. (Comm. v. Duberstein, (S Ct, 1960) 5 AFTR 2d 1626) Recipients may exclude payments that they receive under Code Sec. 102 if they meet the Duberstein standard. If there is a quid pro quo in which the donor receives a tangible economic benefit in return for his contribution, then there isn't a gift.
So, are the rewards that backers sometimes receive for their crowdfunding participation of significant enough value that the donor receives an economic reward (thus negating a gift) or is it an inconsequential economic incentive that can be ignored? While we do not have the IRS’ opinion on the question, the consensus of commentators is that if the crowdfunding is, for example, for the purpose of paying someone’s medical bills, it is likely that the funds will be considered a nontaxable gift. On the other hand, if the purpose of the campaign is, for example, to fund the fundraiser’s independent film project or start or expand a business, the income is likely taxable.
If the fundraising provides equity in a company, then the one raising the capital must treat each contributor as an investor with equity or stock ownership in whatever business entity the venture is using. The SEC, under the regulations noted above, requires that each investor be included in the normal information reporting requirements, which can be quite extensive. In other words, the entity must be treated as a real business.
If A Gift, Is The Amount Subject To Gift Tax? Maybe. Depending on the amount of the contribution, the relationship between the fundraiser and backer, and the total amount of gifts made during the year by the backer to the fundraiser. For 2023 the annual exclusion is $17,000 (up from of $16,000 in 2022) and is available for gifts to each donee.
Are Crowdfunding Project Expenses Deductible?
It depends. Sec. 162(a) allows a deduction for all "ordinary and necessary expenses" paid or incurred during the tax year in carrying on any trade or business provided the taxpayer can show that he engaged in the activity with an actual and honest profit objective. So, to answer the question, you need to know whether the crowdfunding project is a "trade or business" carried on with an expectation of profit, or whether it is an endeavor with no expectation of profit where the payback is other than monetary (e.g., "vanity" publishing).
If it is a hobby, and not a for-profit activity, deductions are only allowed to the extent of income from the activity (and only as a miscellaneous itemized deduction subject to the 2% of AGI reduction, but these deductions are suspended by the TCJA for years 2018 through 2025).
If a trade or business, the service fees charged by the crowdfunding platform would be deductible by an ongoing business, as would the cost of the rewards (mugs, shirts, etc.) discussed above and the costs related to the actual funded project. Start-up expenses up to $5,000 would be deductible if elected by the taxpayer, with start-up costs more than $5,000 amortized over 180 months.
Are Charitable Contributions Allowed to the Backer for His/Her Contribution?
Only if the crowdfunding was sponsored by a qualified Sec 501(c)(3) organization and that organization was the recipient of the funds, and the donor meets all other requirements for claiming a charitable contribution (i.e., itemizes, has required receipt and/or acknowledgment, etc.). Contributions to an individual would not be deductible.
For 2020 only, the CARES Act makes the following changes related to charitable contributions:
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Allows a deduction of cash contributions of up to $300 by individuals that don’t itemize.
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Increases the amount deductible by itemizers by upping the AGI-based limitation from 60% to 100% of AGI for cash charitable contributions.
The penalty for overstatement attributable to charitable contributions claimed by non-itemizers is increased to 50% instead of the normal 20%.
For 2021 only, the following changes concerning charitable contributions were made by the Consolidated Appropriations Act, 2021:
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Allows a deduction without itemizing for cash contributions of up to $600 (joint)/$300 (other statuses).
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The increase of the 60% of AGI limit to 100% of AGI for cash donations to qualified organizations has been extended to 2021 for itemizers.