free money ain’t free - tax implications of crowdfunding

Crowdfunding is the process of soliciting financial contributions for a particular cause from a large number of people, referred to as backers. The financial contributions are used for a wide variety of projects including business ventures, social causes, and support for individuals with a special need. By using social media, projects can gain access to funds outside of traditional sources such as banks or capital markets.

Crowdfunding can create a number of tax issues. In some cases, there is little guidance from the IRS or state governments on how to treat the transactions.

Tax deductions

Generally, contributions to a crowdfunded project will not be deductible unless the recipient is a qualified charitable organization. Contributions to an individual are not deductible.

Gift tax

Unless the backer makes a large gift (over $18,000 in 2024) or has made other large gifts, a gift tax return will not be required.

Capital gains/losses

If the backer receives shares in a company, then a record of the cost basis of the shares and date(s) acquired must be kept. A capital gain or loss will occur when the shares are disposed of or in the event of a project failure.

Loans

If the backer receives interest from a loan to a project, then the interest will need to be reported as income. In the event of a project failure, the backer may be able to deduct the loan as a bad debt.

Taxable income

There is no specific Internal Revenue Code (IRC) section that defines the tax treatment of funds received through a crowdfunding campaign. This means that the receipt of money from a crowdfunding campaign is by default included in gross income, unless there is a specific exclusion listed in the code that states it is not considered gross income.

Gifts

An exclusion from gross income that may apply to crowdfunding is the exclusion for gifts. The IRC and regulations provide examples of gifts but do not define the term “gift.” Courts have ruled that the following may be considered a gift.

• Property given in a spirit of detached and disinterested generosity.

• The excess value of property over the value of consideration received.

Income or gift

An individual or business receiving pledges from a crowdfunding campaign will have to consider the facts and circumstances of the situation to determine if the pledges are income or gifts.

Self-employment tax

A sole-proprietorship operating as a trade or business that has taxable income will owe self-employment tax on the income. However, if the income was received for doing a one-time job and not as regular or continuous activity, then it may not be subject to self-employment tax.

Sales tax

A business providing a product to backers in return for a donation may owe sales tax in the states where the backers reside. Sales tax rules vary widely by state.

Summary

Crowdfunding can be an exciting and successful method of raising funds for individuals in need, causes with social value, and business start-ups. On the other hand, crowdfunding raises business, legal, and tax issues where the rules have not been firmly established.