On March 21, 2022, the IRS issued a fact sheet on the tax treatment of money received through crowdfunding. Crowdfunding is a method of raising money through the Internet by soliciting contributions from many people. In many cases, people establish crowdfunding campaigns to raise money for personal or social causes for themselves or others. In other cases, people establish campaigns to raise money for business ventures.
The 4 Main Types of Crowdfunding
There are four main types of crowdfunding: donation-based, reward-based, equity-based, and debt-based.
- Donation-based crowdfunding: Involves donors giving varying sums of money to support a specific cause with no expectation of receiving anything in return.
- Reward-based crowdfunding: Involves contributors receiving goods or services in return for their donations.
- Debt-based crowdfunding; Akin to peer-to-peer lending and occurs when investors lend money to a business or individual in exchange for repayment of the loan plus interest.
- Equity-based crowdfunding: This allows investors to give money to a business or startup company in exchange for shares in the company.
Although the second two types of crowdfunding may be of interest to the business community, the fact sheet covers only the first two types of crowdfunding, which have become an attractive option for individuals (who may need further tax guidance).
Taxable vs. Non-Taxable
Generally, money received through crowdfunding is included as gross income to the recipient. However, not all payments received are taxable income. Section 61 of the Internal Revenue Code defines gross income to include “all income from whatever source derived unless specifically excluded.” Section 102 of the Code provides that gifts are not includable in the gross income of the person receiving the gift. The IRS, in its March 21st fact sheet, explained that when crowdfunding contributions are made as a result of the contributors’ “detached and disinterested generosity, and without the contributors receiving or expecting to receive anything in return, the amounts may be gifts and therefore may not be includible in the gross income of those for whom the campaign was organized.” The IRS further clarified that a person organizing the campaign on behalf of another may not have to include the money raised in the organizer’s own gross income if the organizer distributes the money to the beneficiary.
Beneficiaries must be wary, however, as not all contributions to campaigns are the result of detached and disinterested generosity. For example, it is unclear whether in a crowdfunding situation that the organizer intends to be donation-based if the provision of any good or service, no matter how small (such as a bumper sticker), could render the crowdfunding payment taxable to the recipient. While IRS regulations exclude goods and services of insubstantial value in determining whether a charitable contribution is deductible, it is unclear whether these guidelines will apply to determine whether crowdfunding contributions are donation-based or reward-based. The IRS fact sheet also cautions that contributions to a campaign by an employer for the benefit of an employee are generally includible in the employee’s gross income.
Form 1099-K
Either the crowdfunding website or its payment processor may be required to report money raised through a campaign to the IRS on Form 1099-K (and furnish a copy to the person to whom the distributions are made) if the amount raised exceeds the reporting threshold and the contributors receive goods or services for their contributions. Before 2022, the threshold was met if the total of all payments to a person exceeded $20,000, resulting from more than 200 transactions or donations during a calendar year. As of January 1, 2022, The American Rescue Plan Act lowered the reporting threshold to $600 during a calendar year, regardless of the number of transactions or donations.
Gift Tax Implications
Donors should also be aware of potential gift tax implications. A contribution to an individual’s crowdfunding campaign that is a gift may be subject to gift tax rules if it exceeds the annual gift tax exclusion limit per individual. Individuals may give gifts of up to $16,000 in 2022 without having to file a gift tax return (excluding gifts to qualifying charities, gifts to spouses, gifts to political organizations, or gifts for tuition or medical expenses).
Accordingly, crowdfunding sites and payment processors, as well as campaign organizers and beneficiaries, should be aware of the new reporting requirements as well as the potential tax consequences to both donors and beneficiaries of crowdfunding donations. Although the fact sheet focuses on donation-based crowdfunding and reward-based crowdfunding it analyzes the tax treatment of the crowdfunding proceeds to the recipient under general tax law principles. Organizers and beneficiaries of debt and equity-based crowdfunding campaigns, therefore, can expect to receive the same type of treatment for tax purposes.
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