Tax Consequences of Crowdfunding
By: Tax Hotline
Summer 2020 (Vol. 38, No. 2)
With the onset of the coronavirus pandemic, crowdfunding websites such as Kickstarter, Indiegogo and GoFundMe have become an increasingly popular way for small business owners to stay afloat. The upside is that it’s often possible to raise the cash you need; the downside is that the IRS may consider that money taxable income.
Crowdfunding is the practice of funding a project by gathering online contributions from a large group of backers. It can be used to fund projects, events, and products, and in some cases, has become an alternative to venture capital.
There are three types of crowdfunding: donation-based, reward-based, and equity-based. Donation-based crowdfunding is when people donate to a cause, project, or event. GoFundMe is the most well-known example of donation-based crowdfunding with pages typically set up by a friend or family member to help the beneficiary pay for medical expenses, tuition, or natural disaster recovery. Reward-based crowdfunding involves an exchange of goods and services for a monetary donation, whereas, in equity-based crowdfunding, donors receive equity for their contribution.
As the agent, or person who set up the crowdfunding account, the money goes directly to you; however, you may or may not be the beneficiary of the funds. If you are both the agent and the beneficiary, you may be responsible for reporting this income. If you are acting as “the agent” only, the funds may be taxable to the beneficiary. Just make sure when you are setting up a crowdfunding account to designate whether you are setting up the campaign for yourself or someone else.
If you use social media, you have probably been asked to help out a friend or family member in crisis by donating to a GoFundMe account. In general, all income received, regardless of the source, is considered taxable income in the eyes of the IRS. However, if the money was donated or pledged without receiving something in return it is usually considered a “gift “ and therefore no taxes are due.
Sites like Kickstarter offer reward-based crowdfunding. Say you develop a prototype for a product that looks promising. You run a Kickstarter campaign to raise additional funding, setting a goal of $15,000, and offer a small gift in the form of a t-shirt, cup with a logo, or a bumper sticker to your donors. Any money raised is considered taxable income and should be reported as such on your tax return even though you may not receive a Form 1099-K from a third party payment processor. Because you include a gift or reward, there could also be a sales tax liability. Generally, crowdfunding revenues are included in income as long as they are not:
- Loans that must be repaid
- Capital contributed to an entity in exchange for an equity interest in the entity
- Gifts made out of detached generosity and without any “quid pro quo.”
- Income offset by business expenses
If your business is a startup you may qualify for additional tax benefits such as deducting startup costs or applying part or all of the research and development credit against payroll tax liability instead of income tax liability.
Typically, companies that issue third-party payment transactions such as Amazon if you use Kickstarter, PayPal if you use Indiegogo, or WePay if you use GoFundMe) are required to report payments that exceed a threshold amount of $20,000 and 200 transactions to the IRS using Form 1099-K, Payment Card and Third Party Network Transactions. The minimum reporting thresholds of greater than $20,000 and more than 200 transactions apply only to payments settled through a third-party network; there is no threshold for payment card transactions.
Form 1099-K includes the gross amount of all reportable payment transactions and is sent to the taxpayer by January 31 if payments were received in the prior calendar year. Include the amount found on your Form 1099-K when figuring your income on your tax return, generally, Schedule C, Profit or Loss from Business for most small business owners.
Tax law can be confusing when it comes to crowdfunding donations. Some third-party payment processors may deem these donations as gifts and do not issue a 1099-K. This is why it is important to keep good records of transactions relating to your crowdfunding campaign including a screenshot of the crowdfunding campaign (it could be several years before the IRS “catches up”) and documentation of any money transfers.