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The Many Tax Implications of Crowdfunding

by
Bob Mason
on
6/19/2017
The Many Tax Implications of Crowdfunding

Internet crowdfunding is a relatively new phenomenon in which money contributions are solicited and gathered via websites. The moneys gathered are sometimes used for charitable purposes and sometimes as an alternative method of financing. The practice has become so popular that an estimated $34 billion was raised in 2015 alone.

Though the practice may seem like a relatively simple process that eliminates red tape and bureaucracy, the truth is that crowdsources via GoFundMe, Kickstarter, Indiegogo and similar sites can raise a lot of tax issues, with many of the answers based on what the money is being used for and how it is being distributed. The various sites charge fees, taking as much as 9% of the monies raised. Each also has its own requirements and limits regarding withdrawals.

Gifts and the Gift Tax Trap

Most people who contribute to a crowdfunding project do so because they believe in the project’s purpose or the product that is being financed. In those instances when people get no personal or business benefit and are providing money based on a desire to provide support rather than out of an obligation or anticipation that they will end up making money from doing so, the IRS considers the contribution that they make a straightforward gift that the recipient is not obligated to pay taxes on.

But making that gift does not mean that there are no tax consequences involved. For instance, those who make a contribution that exceeds $14,000 will find themselves subject to the IRS limit of what may be given to a single individual: they will be required to file a gift tax return, even if the money that is being given as a charitable contribution. A contribution to a crowdfunding site is not a tax deductible charitable contribution – it is viewed as a gift.

The other side of the equation can have a significant impact on the individual that is organizing the fundraising efforts on the crowdfunding site. If a friend or relative raises funds for another who is in need, the fact that the money will be given to a named beneficiary does not eliminate the fact that all of the monies are being given to the organizer. This has been dubbed the “gift tax trap”: as soon as the person raising the funds takes possession of all of the monies raised, it is viewed as a tax-free gift to them. When the fundraising individual turns it over to the person who was the actual subject of all that generosity they (the fundraiser) is viewed as the person giving the gift, and if that amount is greater than $14,000, they have to reduce their own lifetime gift and estate tax exemption by however much they are giving, and they have to file a gift tax return with the government.  Though some of the crowdfunding sites have addressed this issue by allowing a beneficiary to be named as the recipient and to have direct access to the funds provided, not all of them have taken this step. It is necessary for organizers to pay attention to this detail in order to avoid an unnecessary tax disadvantage.

Crowdfunding for Charity

When a crowdfunding effort is specifically designated as going to a qualified charity, contributors are able to take the charitable contribution deduction, but only if they meet the same documentation requirements that are in place for direct charitable contributions. These requirements are dependent upon the amount that is given:

  • Under $250, contributions can be deducted as long as the taxpayer is able to provide proof in the form of a letter from the qualified charity that shows its name, the contribution date, and the amount that the charity received. The taxpayer is also able to use a bank or credit card statement that reflects the contribution or a cancelled check.
  • At  $250 or more, taxpayers who want to deduct a charitable contribution need to have the same type of written acknowledgement from the charity as listed above, but the receipt also needs to provide information about whether there any goods or services were provided to the contributor outside of membership benefits or small tokens of appreciation. If goods or services were provided in response to the contribution, the charity also needs to include in their receipt a description and good faith estimate of their worth. This does not apply if the service was deemed to be an intangible religious benefit. If that is the case, then the receipt must indicate that the religious benefit was the only benefit received.
  • To claim a deduction for a contribution of $250 or more, the taxpayer must have a written acknowledgment of the contribution from the qualified organization; this acknowledgment must include the following details:

The requirements shown here are standard for charitable contributions of all types, but may be made more complicated by the crowdfunding process. In all cases, in order for the contributor to be able to deduct their contribution to a charity, the charity must be able to provide them with a receipt for the monies received.

Crowdfunding Business Projects

Crowdfunding has also become a highly successful way for new business ventures to raise capital. This process also has tax ramifications, as the money raised may be considered taxable and there are SEC (Security and Exchange Commission) regulations that recipients must adhere to, particularly where an ownership interest is provided to the contributor. There are two different scenarios that need to be considered: 

  • Where no Business Interest is Provided to the Contributor – in these cases the business that receives the contribution is responsible for paying taxes on the funds raised, and the contributor is given only token items such as a T-shirt or coffee cup, or a product from the business.
  • Where a Business Interest is Provided to the Contributor  - in these cases the business that receives the contribution can record the money as a capital contribution, and is not responsible for paying taxes on the funds raised. The contributors’ contributions are considered their tax basis in the business and the contributors are provided with partial ownership of the business. This may take the form of a partnership interest or stock. These transactions require that the ownership interests comply with the regulations of the SEC.

In 2012, when crowdfunding started to become popular, the SEC created special exemptions that addressed the issues raised by their unique methodologies and processes. These exemptions include:

  • Maximum Amount to be Crowdfunded – The SEC allows a certain amount of money to be raised within a one-year period through crowdfunding without registering. This maximum amount is $1 million: beyond that amount of money it is necessary for the business to register its offering.  This opportunity is not available to certain categories of businesses, including those that do not have a business plan, certain investment companies, companies that are not based in the United States, companies that do not report under the Exchange Act, and those who have previously not complied with their SEC reporting requirements.
  • Maximum Amount to be Contributed – In addition to placing limitations on the amount that can be raised, individual contributors are also limited in the amount that they are able to invest within a one-year period. These limitations are as follows:
  • Those who wish to purchase an equity investment via crowdfunding but whose net worth or annual income is under $107,000 are limited to either 5 percent of their net worth of $2,200, whichever is the higher amount.
  • Those who wish to purchase an equity investment via crowdfunding and whose net worth or annual income is $107,000 or more are limited to either $107,000 or 10% of their net worth or annual income, whichever adds up to the lesser dollar amount.

Crowdfunding is a convenient way to make contributions to worthy causes and business ventures, but it is not without tax ramifications. Before taking any steps that may result in a negative or unexpected tax exposure, it’s a good idea to speak to your tax professional.

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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.

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