Key insights
- The IRS's position is that crowdfunding proceeds are includible in gross income, unless otherwise excluded under federal income tax law.
- The ultimate tax treatment of a crowdfunding transaction will depend on the facts and circumstances underlying a specific case.
- Rewards-based crowdfunding raises multiple tax questions on valuation, deductions, and offsetting proceeds.
Is your crowdfunding project tax-compliant?
You may have seen it before. Someone shares a post on social media asking for financial support, whether it be to help pay for medical expenses, fund a personal project, or something in between. It’s called crowdfunding — a modern-day approach to raising capital by collecting donations from people through online platforms. Yet this simple practice can raise complex tax issues for the beneficiary, and the ultimate tax treatment may vary depending how the proceeds were derived.
In 2016, the IRS issued guidance on how to approach the federal income tax treatment of crowdfunding proceeds. Review some key points that could help your crowdfunding project stay compliant.
Are crowdfunding proceeds includible?
As a starting point, the IRS’s position is that crowdfunding proceeds are includible in gross income, unless otherwise excluded under federal income tax law. The IRS further elaborates by stating crowdfunding revenues generally are includible in income if 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”
Of course, the ultimate tax treatment of a transaction will depend on the facts and circumstances of a specific case, such as whether the taxpayer has been granted access to the funds and any actual or self-imposed restrictions on such access.
Potential exceptions to the rule
Although the thought process outlined by the IRS may appear straightforward, applying these guidelines to real-world transactions is more challenging.
For example, donation-based crowdfunding is the traditional function of fundraising — which provides no financial return to contributors. At first blush, it appears the beneficiary could exclude proceeds from gross income on the theory that the amounts received constitute gifts.
Nevertheless, the IRS may take issue with this position if the beneficiary uses the proceeds to fund a project whose output could be used by the donor (e.g., online music), or if the beneficiary is unable to identify an anonymous donor to establish “donative intent” as part of an audit inquiry.
Tax challenges for rewards-based crowdfunding
Similarly, in a rewards-based crowdfunding, the beneficiary agrees to issue a product, service, or other token of appreciation to the donor in exchange for a cash contribution. This type of transaction raises multiple tax questions:
- How to value the consideration transferred to the donor
- Whether the beneficiary can deduct the consideration so transferred
- Whether the beneficiary can offset the crowdfunding proceeds (i.e., gross income) and the donor consideration (i.e., deductions) in the same year for purposes of computing his or her federal taxable income and income tax liabilities
How we can help
The federal income tax treatment of crowdfunding transactions is uncertain and requires a deep dive into the details of a given transaction. This is one of many “digital economy” transactions that should be vetted by trusted tax advisors. Our team of professionals can assist you throughout the entire tax preparation and planning process to help you file with confidence.