Crowdfunding – Category Determines Taxation
Crowdfunding, like campaigns you see on sites like Kickstarter or GoFundMe, can essentially be categorized into three types of transactions:
- Equity investment – the funds received purchase ownership interest.
- Gift – the funds received are given with no expectations of a return and a token gift is given in return (e.g., a t-shirt or mug)
- Income – money received for your work.
What most crowdfunding groups or individuals forget to consider are the tax implications of their efforts. It’s crucial that you can answer the following questions about the proceeds from your crowdfunding:
- What category did my past and present crowdfunding (if any) fall into?
- Based on that categorization, was there taxable income/revenue received? If so, how much?
- What are the taxes owed (if any, and most will owe taxes)?
- What do I need to do to handle this situation?
- What strategy do I need for future crowdfunding efforts?
“Grossing up” Your Fundraising Targets
When raising funds, you are typically raising sufficient funding to cover a significant period of time: one year or more. You have planned expenditures, but they won’t necessarily occur all within the same tax period (year). Therefore, it is critical to understand the timing of receipts and expenditures as they relate to creating taxable income from crowdfunding. If you walk through the following example, I think things become clearer.
You need to raise $500,000 to cover working capital and research costs for an 18-month period. Your tax/financial year ends on December 31. You raise the funds between March 1 and June 30. You receive the funds into your account on July 1. You are a C Corporation, so the business files and pays its own taxes. Planned uses of these funds include $100,000 equipment order in July, hiring of two researchers in August resulting in monthly payroll obligation of $12000, and miscellaneous other expenses of $5,000 per month, beginning in November.
In planning how much to raise, you will want to take into consideration tax rates. The amount you need becomes the net amount to raise. If your tax rate is 35% and you need $500,000, then you will need to raise approximately $770,000 to your target funds needed.
Interpreting the IRS information letter
The IRS, in its review of crowdfunding, concluded that where money is received without an offsetting liability (a repayment obligation) nor is it a capital contribution in exchange for ownership interest (stock, member unit) and it isn’t a gift results in taxable income.
So if your crowdfunding is not a loan to be repaid, nor is it a purchase of ownership interest, and it does not meet the IRS definition of a “gift,” then it is income and subject to income tax.
Develop Your Proactive Tax-management Crowdfunding Strategy
- How much money do you need to raise?
- Will you be issuing stock or creating a liability to repay the funds raised?
If yes, then go no further.
If no, go to step 3.
- Will you be providing a “token” in return for the funds: a mug, t-shirt, or some item of nominal value to the fund source?
If yes, most likely funds will be a “gift.”
If No, proceed to 4.
- Are you a C corporation?
If yes, then identify your tax rate.
If no, go to step 5.
- Are you a flow through entity (S Corporation or LLC)?
If yes, then estimate the potential flow through and tax impact on owners.
If no, proceed to step 6.
- You must be a sole proprietor or partnership. As in step 5, you need to determine the potential impact for taxes on personal statements.
Summing It Up
In general terms, crowdfunding revenues are considered income if they are not:
- Loans that must be repaid;
- Capital contributed in exchange for an equity interest in the entity; or
- Gifts made out of detached generosity and without any “quid pro quo.”
If funds are received for services rendered or are gains from the sale of property as part of a crowdfunding process, then those funds are income and taxable.
 I should note that while funds maybe gifted and not counted as income, a gift of any type including money may be subject to a gift tax. The IRS on its website states: Gift Taxes (https://www.irs.gov/businesses/small-businesses-self-employed/gift-tax)
“The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not.
The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.”
Copyright ©2016 Lea A. Strickland, F.O.C.U.S. Resource, Inc.