Menu

Tax Strategies & Credits

Crowdfunding: Watch out for These Unexpected Consequences

by
Bob Mason
on
9/23/2019
Crowdfunding: Watch out for These Unexpected Consequences

Crowdfunding has quickly become one of the easiest and most popular ways to fundraise. Whether you’re an inventor who is looking for funding help as you develop and market a new product or a Good Samaritan trying to help a family in need, sites like GoFundMe, Indiegogo and Kickstarter have made setting up a funding page a breeze for both you and your contributors.

Though it may initially feel like the only costs involved with crowdfunding are the fees imposed by the platforms, accepting and distributing money — especially big money — almost always has some kind of tax consequences. Here’s what you need to know before you decide that crowdfunding is for you.

Raising Money for Yourself or for Another

When you set up a fundraising page to help pay for a “worthy cause,” the people who donate do so out of a sense of generosity rather than because they believe they are going to get a tangible economic benefit or because they have a legal obligation to do so. The monies that they contribute are considered gifts to the person who will benefit from them. The IRS does not consider gifts taxable to the recipient, but if a single donor gives more than $15,000 to a single person within a year, their contribution counts against their lifetime gift and estate tax exemption and a gift tax return would need to be filed. The gift is not treated in the same way as a charitable contribution, and is therefore not tax deductible.

This rule can have a significant impact on an individual who sets up a fundraiser that will benefit somebody else. Care needs to be taken in how the organizer or administrator arranges for monies to pass to the beneficiary.

If the organizer is the person who is receiving the money with the intention of then distributing it to the person in need at a later date, they can get themselves into trouble: even if they are only in possession of the funds for a short period of time, as soon as they transfer it to the beneficiary the IRS will look at the transaction as a gift from the organizer, and therefore count against the organizer’s lifetime gift and estate tax exemption. If you are in a financial position where this has the potential to work against you, check with the crowdfunding site to see whether they offer a way of allowing the beneficiary direct access to the funds without you getting involved in the transfer.

There’s an interesting tax twist on using funds from crowdsourcing (or any other type of gift): The recipient of these funds is able to use them without paying tax on them, and if their medical expenses are high enough for them to itemize and take the medical expense deduction on Schedule A, they can do so even though dollars that were not taxable to them were used.

Raising Money for a Charity

Sometimes crowdfunding sites are used to help raise money for a qualified charity. If a donation is made in this way, the donor is able to take the charitable contribution deduction as long as they fulfill the same documentation requirements that are applicable to any other charitable giving. These are:

  • For contributions under $250, the taxpayer must be able to present proof that includes the charitable organization’s name and the date and amount of the contribution. This can be in the form of a cancelled check, a statement from a credit card company or bank, or a letter of receipt from the charity.
  • For contributions of $250 or more, the taxpayer must have a letter or some other type of hard-copy acknowledgement of their donation from the charitable organization. The letter or receipt must note the dollar amount received and whether the donor was provided any type of good or service in exchange for the donation, noting what was received and a good faith representation of its value. This is not necessary for token items and membership benefits. If the only benefit received was in the form of a moral or religious benefit, that should be noted on the statement.

Raising Money for a Business Venture

Kickstarter and similar platforms have notably raised money for many promising and exciting business ventures, but entrepreneurs need to take care before they choose to use this approach. There are tax issues that need to be addressed, as well as regulations imposed by the Security and Exchange Commission (SEC) when contributions are made in exchange for shares in the organization. Here’s what you need to know:

  • Where the crowdfunding does not provide business ownership the money is taxable to the fundraiser. This is the situation when the contributors receive the chance to be early adopters or of a new product, or receive promotional gifts such as keychains, tee shirts, or future discounts on purchases. Where these contributions are considered income, they are likely to be used as tax deductible business expenses, which makes their taxable status more palatable.
  • Where the crowdfunding does provide business ownership the transaction is viewed as a capital contribution. It is not taxable to the fundraiser and the amount that is given is viewed as the investor’s original tax basis. This is the situation when the contributors are given partial business ownership or shares of stock. In similar fundraising scenarios, the SEC requires notification and registration of the offering, but for crowdfunding the following rules have been put in place:
  • Businesses are not permitted to raise more than $1.07 million during a 12-month period without registering with the SEC. This special exemption is not available to businesses without a business plan, non-U.S. companies, companies that report under the exchange act, some investment companies and companies that have previously failed to fulfill their reporting obligations.
  • An annual limit is imposed on how much a single donor can contribute via a crowdfunding platform within the period of a year. This limit is based on annual income or net worth.
  • Equity investment through crowdfunding is limited to either 5% of net worth or $2,200 (whichever is greater) for those with an annual income or net worth of less than $107,000.
  • Equity investment through crowdfunding is limited to either 10% of net worth or their annual income for those with a net worth or annual income of $107,000 or more. The aggregate limit is $107,000.

Some have suggested that the question of whether crowdfunding money is taxable is irrelevant because the IRS doesn’t track crowdfunding. That is a theory that is not particularly reliable, especially because where funds are processed through third-party transaction companies such as credit cards or PayPal, the processors are required to provide reporting where funds meet or exceed $20,000 or 200 transactions per year.

If you are about to embark on some kind of crowdfunding effort and you want to make sure that you’re going about it the correct way, contact a tax professional for more information.

Bob Mason, CPA writes for TaxBuzz, a tax and accounting news and advice website. Reach his office at [email protected].

share this post
Search for matches...
Bob Mason

Bob Mason

Bob Mason is the founder of Coast Financial Services Inc. servicing both the Santa Cruz, and San Jose areas. Bob Mason is a skilled financial professional who is fully equipped to assist any of your accounting needs. Founding his firm in Santa Cruz, Bob understands the importance of small businesses and how they form the backbone of the area. Coast Financial Services, Inc. has been dedicated to the growth and profitability of businesses in Santa Cruz for 17 years. To learn more about Bob Mason and the rest of his team, visit their website.

COAST FINANCIAL SERVICES, INC.
★ ★ ★ ★ ★
1 review

California

Firm Profile

Recommended Professionals

In the face of economic uncertainty, TaxBuzz is the industry's most up-to-date tax information.

Join 60,000 who get our weekly newsletter. No spam.

We know tax and accounting issues are complicated.

Do you have additional questions on this topic for this author?

Related Posts

Latest Posts