Comprehensive guide to crowdfunding taxes
Crowdfunding can be an excellent way to finance your upcoming project. Many companies opt to crowdfund their operations, allowing them to “kickstart” their products and services. In a nutshell, crowdfunding allows individuals and companies to raise money from the contributions of a large number of people. But when it comes to crowdfunding taxes, the topic gets rather complex. Even IRS tax relief specialists are sometimes puzzled by crowdfunding taxation rules. That is why this article is going to shed some light on the matter. We will explain what exactly crowdfunding is and how it gets taxed.
What is crowdfunding?
You might have already encountered the term “backer”. This term represents someone who provides a financial contribution to a crowdfunding project. Basically, crowdfunding is the act of soliciting financial contributions from a large number of backers, usually over the internet. While it is possible to crowdfund a project without online assistance, it is much more difficult.
At times, crowdfunding can also enable businesses and individuals to expand their original vision. For example, if a crowdfunding campaign suddenly receives extreme attention (and more money), it may be possible to expand the scope of the project, hire more people, etc. But if you want to cut your tax bills through crowdfunding, there are a couple of things to know. You need to be able to understand how crowdfunding and taxes “mesh” together. And that is exactly what the next section is all about.
Crowdfunding taxes 101
To understand crowdfunding better, we need to answer the following questions:
- Is crowdfunding income subject to taxation?
- How how does the IRS treat income through crowdfunding?
- What do I need to know about crowdfunding taxes if I am an individual?
- What do I need to know about crowdfunding taxes if I run a business?
- What is equity-based crowdfunding?
- What is reward-based crowdfunding?
- What is Form 1099-K?
- Can I deduct crowdfunding contributions?
There are three major types of crowdfunding. There’s personal fundraising (individual or business), creative enterprise crowdfunding (reward-based), and raising capital for companies (equity-based crowdfunding). And all of them follow a different set of taxation rules. If you are looking to protect your income from taxes, you need to know these rules. Let’s take a look at that now.
Can crowdfunding income be taxed?
Since we are devoting an entire article to the topic, the answer is “Yes”. For the most part. The taxation rules depend on the crowdfunding type. For example, crowdfunding for IRS-recognized charitable purposes is not taxed at all. But almost every other crowdfunding project is subject to taxation. According to the IRS, if the contributions are made as a “result of the contributors’ detached and disinterested generosity” and without any of the backers expecting or receiving anything in return, only then can you not include them in your gross income.
To illustrate the point, if thousands of people each donated $1 to help pay for the medical treatment of another person, the person would not need to report that income on their tax return. But if that same person offered, let’s say, a small drawing sketch for each dollar, then that income may be fully taxed according to the IRS ruleset.
IRS treatment of crowdfunding income
If crowdfunding income is not in the form of a gift, the recipient needs to include it in their gross income. Meaning that it is fully taxed according to the state. Some of the best states for property taxes also have the most lenient crowdfunding taxes, as well. However, there is another “catch”. If the recipient distributes the funds to a charitable goal, one that is also recognized by the IRS, that income may not be subject to taxation, either. But that is usually not the case. There are almost always some expenses that the recipient incurs and uses the money for, which may not be purely altruistic.
Furthermore, even if you receive income through crowdfunding as a gift, that does not necessarily mean the IRS will see it that way as well. The best thing to do is to consult a tax professional and have them help determine how your income may be taxed.
Crowdfunding taxes for individuals
Most of the time, individuals receive crowdfunding income when they are in “dire straits”. This usually constitutes a gift, as the backers are not getting anything in return. For example, if someone’s house is burned down and they receive contributions that will go toward repairing it, the money received is not subject to additional taxation. Even so, if a single donation exceeds the gift tax limit ($16,000 in 2022), it will be subject to the gift tax. Luckily, that gift tax is paid by the donor.
Overall, individual crowdfunding income is seldom taxed. Provided, of course, that the backers do not receive any sort of compensation. A small token of appreciation might be trivial, but you can also consider it a form of reward. In that case, it is not crowdfunding for individuals, it is reward-based crowdfunding.
Crowdfunding taxes for businesses
Most businesses run reward-based crowdfunding. Therefore, most of the time, this income will be fully subject to taxation. However, the same business can opt for equity (regulation) crowdfunding instead. Each option has a different set of tax implications and comes with its own popular tax deductions. Another thing to note is that in some cases, part of the crowdfunding income might not be taxable. This is a very specific topic, however, and you might want to discuss it with your tax professional. But for now, let’s explore the two main crowdfunding types that businesses use.
Also known as regulation crowdfunding, this type allows the backers to have a financial stake in the company they are pledging money to. Most of the companies that utilize this approach are startups. But why do the companies do this? Well, the income that comes from this crowdfunding type is not subject to business taxes. The company is not providing any goods or services to the backers, after all. What the company does offer are various securities.
Of course, the SEC (Security and Exchange Commission) heavily regulates this entire process. They ensure that both the company and the backers “play nice” and do not try to exploit the system.
This is the most common crowdfunding type. When a backer pledges their money to the campaign, they expect something in return. In most cases, the income from reward crowdfunding is fully taxable. The backers offer their money and they get something of value as their reward. Simple, right? However, when the reward value is really hard to determine, things get “muddy”.
For example, let’s say that the backers receive a “thank you” note. Normally, a handwritten note has very little value to the backer. But if the note itself is a “collectible item”, then the reward is much more significant. Perhaps the note is expertly folded or customized. Maybe the parchment itself is somehow valuable? All we’re saying is that there are numerous things that can make determining the note’s value very hard. Value, after all, means different things to different people. Someone is willing to pay hundreds of thousands for someone else’s autograph, for example. And someone finds absolutely no value in that autograph. The important thing is what the IRS thinks.
Basically, if there is any value in the reward, crowdfunding income is taxable. Otherwise, it is not.
Form 1099-K – Reporting distributions of money raised through crowdfunding
If a crowdfunding campaign raises enough money (more than $600), the organizer (usually a website) or its payment processor may need to report the distribution of money. Prior to 2022, the threshold used to be $20,000, distributed through 200 or more transactions/donations. As you can see, that is a very drastic change, indicating that crowdfunding is getting a lot more attention recently. In any case, if the crowdfunding income passes the threshold, the website or the payment processor needs to file Form 1099-K with the IRS. Furthermore, either the crowdfunding organizer needs to get a copy, or the individuals or businesses that solicit funds from the campaign need a copy.
The reason why Form 1099-K is so important is due to the fact that if the websites do not report distributions properly, there can be far-reaching tax implications.
Are crowdfunding contributions tax deductible?
You cannot deduct crowdfunding contributions in most cases. The only time when you can is when you are a charitable organization that is also recognized by the IRS. No matter how noble the cause might be, the contribution itself is usually not deductible. While this may sound very harsh (and it is), the rules are there to discourage scams and prevent tax fraud. Crowdfunding taxes are quite complex as they are, and providing tax deductions to certain cases and not others is simply opening a big can of worms, so to speak.
For more information on every tax type and recommendations on the best tax relief companies in the country, refer to Consumer Opinion Guide. Our expert staff is there to help you find the answer to any question you might have!