Gone are the days of standing outside grocery stores with collection jars to raise money for a good cause. Crowdfunding websites have streamlined the process of collecting donations for thousands of charities, entrepreneurs, films, games, medical/hospital expenses, etc., and make it easier to reach a wider audience of possible donors than ever before. Funds created through sites such as Kickstarter, IndieGoGo, and GoFundMe are easy to use, but for fund organizers, the money collected may be a taxation minefield, as donations can be inadvertently categorized as taxable income, and not gifts. Additionally, donors who plan to contribute more than $14,000 to a campaign in a calendar year could be required to file a gift tax return to report the gift in excess of $14,000. Since crowdfunding is now a $5.5 billion industry, prospective organizers need to understand that if their website pages do not adhere to the form of a gift or donation, they may find themselves subject to IRS scrutiny and audit.
The IRS has not released any formal rulings directly addressing the taxability of contributions to crowdfunding projects. Instead, they recommend the application of general tax rules to donations, and advise that the taxability of donations depends on the specific factual circumstances surrounding the crowdfund.
Generally speaking, gross income does not include the value of property acquired by gift, bequest, devise, or inheritance; thus, it does not have to be reported. Donors and crowdfunds that raise money for third parties are similarly exempt from taxes. While most crowdfunds fall into these tax-exempt categories, improper setup of the fund and certain actions taken after the donation may put organizers and donors at risk for an IRS audit and/or tax assessment. Thankfully, awareness of common tax pitfalls can mitigate or eliminate the chances of this happening.
Classification as a Donation-Based Crowdfund
Crowdfund organizers do not have to report donations if donors don’t receive anything in exchange for their donations or contributions. To be classified as a donation-based crowdfund, in which contributions are considered nontaxable gifts, the fund must pass a three-part test:
- The intent of the donor must be that of generosity, compassion, affection, or charity (giving something for nothing);
- There must be acceptance by the individual managing the fund; and,
- There must be delivery and transfer of what is collected to the parties specified in the fund’s description.
Identifying Proper Parties in the Site’s Setup
For individuals with wealthy donors or a high fundraising goal, it is important to register the crowdfund’s account under the name and tax identification number of the person handling the funds, or the fund’s beneficiary. If donations are deposited into the account of a third-party or organizer, then transferred to the intended party, all funds exceeding $14,000 annually must be reported by the donor on a gift tax return and then will deducted from the donor’s lifetime gift-giving maximum which is currently $5.49 million. To ensure that the collected moneys are utilized for their intended purpose, rather than possibly taxed, register crowdfunds with the benefitted party when raising money that is expected to exceed $14,000.
Additionally, in accordance with the California Attorney General’s Office guide on crowdfunding, fund organizers are encouraged to remain transparent with donors, accurately communicate the purpose of the donated funds, and disclose if any amount of donated money will be diverted to other purposes or third-parties. Misrepresentation of information surrounding the nature and purpose of the fund may be in violation of California charity law.
After the Donation, Handle Funds and Register Appropriately
After ensuring that the site may be classified as a donation-based crowdfund, designation of the proper parties, and appropriate explanation of the nature of the fund, organizers of donation-based crowdfunds need to properly handle their donations to avoid tax issues. Problems may arise if the donations are commingled with personal funds, organizers fail to keep proper record of donations, or fail to transfer the money to the parties specified in the fund’s description. Keeping appropriate records and depositing money into one bank account that is only used for purposes fully described in all crowdfund materials is essential.
Additionally, crowdfunds that accept rolling and continual donations need to comply with statutory requirements for charitable solicitations, and may need to register as a charity, depending on locality. In California, crowdfunds with gross receipts of more than $25,000 will receive an IRS Form 990 and/or Notice to Register, and will need to register with the California Office of the Attorney General as a charity. California charities that use unregistered fundraisers may be subject to penalties.
Receiving a 1099-K
The payment processors for websites such as Kickstarter, IndieGoGo, and GoFundMe must report to the IRS when a hosted campaign both raises $20,000 and receives more than 200 donations. This mandatory report (a 1099-K) is sent to both the crowdfund and the IRS. The 1099-K was originally developed to report credit card and debit card transactions of a business, like hotels and restaurants, but it is a fairly new concept to crowdfunding. If a 1099-K is received for a charitable and donation-based crowdfund, organizers should proactively contact the IRS and explain the specific nature of the fund to avoid an audit assessment. Additionally, organizers can protect their funds by creating a Memorandum of Understanding clearly stating their intent in fundraising, designating the charitable nature of the site, and explaining the intended use for all collected moneys.
Rewards-Based Crowdfunding and Avoidance of Valuable Consideration
Unlike donation-based crowdfunds, that do not provide donors with anything in return, reward-based crowdfunds are typically business-oriented, and offer gifts to incentivize or thank donors for their contributions. The IRS specifies that a gift is any transfer to an individual where full consideration is not received in return. When donations are given in the hope of receiving something of equal value, or to make an investment in a company, the donation is no longer considered a gift, and is regarded as taxable income to the donee crowdfund. For most crowdfunding campaigns offering donation incentives, the rewards are small and nominal in nature, and do not meet the threshold of equal or nearly equal consideration. However, when offering rewards that match or nearly match the value of the donation, it is more likely than not that you have crossed over the line and allowed your donations to be treated by the IRS as taxable income rather than gifts. To ensure that rewards-based crowdfunds do not fall into this trap for the unwary, rewards need to be minimal and disproportionate to the value of the donation. For example, if you offer a book that normally sells for $14.99 as a gift for every donation of $1000 or more, your crowdfund is probably safe; but, if you offer the same book for every donation of at least $15, it is highly likely that the IRS will treat the donation as taxable income. In addition, the California Department of Tax and Fee Administration will want you to collect sales tax on the book proceeds since they constitute gross receipts.
When in Doubt, Contact the IRS
The IRS recommends that organizers unsure as to whether their crowdfund donations are gifts or taxable income should obtain a private letter from the IRS which will apply the law to the fund’s specific facts. To receive a private letter ruling, see the Rev. Proc. 2016-1 I.R.B. 1, available at www.irs.gov.
Individual donors may give gifts of up to $14,000 a year per person without having to file a gift tax return (and may give over $14,000 if the gifts are for tuition, medical expenses, or gifts to spouses, or gifts to political organizations). However, if a donor gives more than $14,000 to a person in any year, the excess must be reported on a gift tax return and that excess is deducted from the donor’s individual $5.49 million lifetime exception.