Whether for startups, charitable causes, creative projects, or personal needs, crowdfunding has grown exponentially as a means of raising capital. However, as the crowdfunding landscape evolves, so does the tax treatment of the funds raised through these platforms. Anyone looking to fund a project through crowdfunding should have a clear understanding of the taxability of crowdfunding in various contexts and recognize that tax laws vary by jurisdiction and are subject to changes.
Types of Crowdfunding
Crowdfunding generally falls into one of four categories:
- Donation-Based Crowdfunding: Individuals contribute money without expecting any form of return.
- Reward-Based Crowdfunding: Donors receive a product, service, or token of appreciation in exchange for their contribution.
- Equity-Based Crowdfunding: Investors provide funding in exchange for equity or ownership in a company.
- Debt-Based Crowdfunding (Peer-to-Peer Lending): Investors lend money to individuals or businesses with the expectation of repayment, usually with interest.
Each of these crowdfunding models can be treated differently from a tax perspective, depending on the nature of the contributions and the jurisdiction in which the funds are raised.
Tax Implications for Donation-Based Crowdfunding
Donation-based crowdfunding involves raising funds without any expectation of receiving something in return. Popular platforms for donation-based crowdfunding include GoFundMe and Facebook Fundraisers.
- For the Recipient:
- Gifts: Generally, if the contributions are considered gifts given out of "detached and disinterested generosity" (i.e., without expecting anything in return), these donations are not taxable to the recipient.
- Business or Income-Generating Activities: If the funds are used for a business or in any activity that generates income, the IRS may consider the funds as taxable income.
- IRS Guidance: The IRS has clarified in a 2016 information letter that if crowdfunding proceeds are considered gifts, they are not taxable. However, if they exceed the IRS gift exclusion limit (set at $17,000 for individuals in 2024), the donor might be required to file a gift tax return. This applies only to donors and typically doesn't affect the recipient's taxes.
- For the Donor:
- Donations to a personal campaign (e.g., helping someone pay medical bills) are not tax-deductible unless the funds go to a qualified charity (like a 501(c)(3) organization).
- If a donation is made to a nonprofit organization with tax-exempt status, the donation is typically tax-deductible for the donor, subject to IRS rules.
Tax Implications for Reward Based Crowdfunding Reward-based crowdfunding is where contributors receive a product, service, or other rewards in exchange for their financial contribution. Platforms such as Kickstarter and Indiegogo operate on this model.
- For the Recipient:
- Taxable Income: Funds raised through reward-based crowdfunding are generally treated as taxable income because they are payments in exchange for goods or services.
- Gross Income: According to the IRS, the total amount received through crowdfunding is considered gross income and must be reported on tax returns.
- Business Expenses: Crowdfunding campaign creators can generally deduct business expenses related to producing the goods or services offered (e.g., production costs, shipping, marketing).Form 1099-K: If a campaign raises more than $600 in gross receipts via credit card, debit card, or third-party payment processors (e.g., PayPal), the platform may issue a Form 1099-K, which reports the total payments received to both the IRS and the taxpayer.
- For the Donor:
- Not Tax-Deductible: Contributions made in exchange for rewards (such as products or services) are considered purchases and are not tax-deductible.
Tax Implications for Equity Based Crowdfunding Equity-based crowdfunding involves raising capital by offering shares of the company to backers, who become equity investors in the business. Platforms like WeFunder and SeedInvest facilitate equity crowdfunding.
- For the Recipient (Company):
- Not Taxable Income: Money raised through equity-based crowdfunding is generally treated as investment capital, not taxable income. The funds are exchanged for equity or ownership in the company rather than as payment for goods or services. Future Taxation: Though the funds raised are not taxable at the time of the crowdfunding, any future sales of equity or dividends paid out to investors could trigger taxable events for both the company and the investors.
- For the Investor:
- Capital Gains Tax: When investors sell their equity in the future, they may be subject to capital gains tax on any profit realized from the sale.
- Dividend Tax: If the company pays dividends to its equity holders, the dividends are usually subject to taxation as ordinary income or qualified dividend income, depending on the investor's situation.
Tax Implications for Debt-Based Crowdfunding
Debt-based crowdfunding, also called peer-to-peer lending, involves raising funds in exchange for a promise to repay the lender with interest. Examples include platforms like LendingClub or Prosper.
- For the Borrower:
- Not Taxable Income: Funds received through debt-based crowdfunding are considered loans and are not taxable because they are expected to be repaid.
- Forgiven Debt: If the loan is forgiven or written off, the amount of the forgiven debt could be considered taxable income under the IRS’s "cancellation of debt" rules.
- For the Lender:
- Interest Income: Any interest earned on the loan is considered taxable income and must be reported to the IRS. Lenders will generally receive a Form 1099-INT for the interest income if it exceeds $10.
- Capital Loss Deduction: If the borrower defaults and the loan is not repaid, the lender may be able to claim a capital loss deduction on their tax return.
IRS Reporting and Record-Keeping Requirements
Form 1099-K: Many crowdfunding platforms are required to issue Form 1099-K to recipients who receive over $600 in payments through third-party networks. This applies to business transactions, reward-based crowdfunding, and other taxable receipts.
Self-Employment Tax: If the funds raised are used to support a business or an activity in which the recipient is actively engaged, the income may be subject to self-employment tax, in addition to income tax.
Record-Keeping: Crowdfunding recipients should keep detailed records of all funds received, how they were used, and any associated business expenses. This documentation is essential for accurate tax reporting and claiming deductions.
Crowdfunding and Sales Tax
For reward-based campaigns, especially those involving the sale of physical goods, sales tax obligations may apply. Sales tax rules vary by state and municipality, and campaign creators must determine whether they need to collect and remit sales tax on the goods delivered to backers.
International Tax Implications
Tax treatment of crowdfunding can vary significantly from country to country. Some jurisdictions may treat certain types of crowdfunding as taxable income, while others may exempt specific types (such as donations or gifts). For example:
- United Kingdom: Donations given without a reward are typically not taxable, but funds received in exchange for goods or services are subject to income tax. Equity-based crowdfunding is subject to tax relief schemes like the Seed Enterprise Investment Scheme (SEIS) or the Enterprise Investment Scheme (EIS), which can provide tax advantages to investors.
- European Union: Crowdfunding platforms in the EU are required to adhere to specific regulatory frameworks. Taxation depends on whether the funds are considered donations, investments, or sales.
Given the complexity of international tax laws, it's crucial for both recipients and contributors to understand the rules applicable in their jurisdiction.
Conclusion
The taxability of crowdfunding depends on several factors, including the nature of the crowdfunding campaign, the relationship between contributors and recipients, and local tax laws. In general, donation-based crowdfunding is the least likely to be taxable, while reward-based crowdfunding is typically treated as taxable income. Equity and debt-based crowdfunding have their own unique tax treatments.
For anyone involved in a crowdfunding campaign, it's important to keep detailed records and consult with a tax professional to ensure compliance with all relevant tax laws. Each case can be different, and a tax expert can provide tailored advice based on the specifics of the campaign and the jurisdiction involved.
