Crowdfunding...What are the Tax Considerations?October 17, 2016
Learn more about the tax implications of using this finance model.
Crowdfunding, a relatively new model in finance has quickly become a popular alternative to venture capital investing. How are these models taxed, you might ask? The IRS recently released an information letter that aims to explain the tax treatment of crowdfunding, but the letter leaves many with remaining uncertainties about their tax obligations when it comes to this new finance model.
Businesses and entrepreneurs can solicit online contributions from multiple parties through crowdfunding. Kickstarter and AngelList are both popular crowdfunding platforms, and each has some kind of “rewards” program based on the contributions received (donors get T-shirts, concert tickets, or other items of minimal value).
Originally used by filmmakers and musicians, crowdfunding use has now expanded to a variety of industries (following the enactment of Title III of the Jumpstart Our Business Startups (JOBS) Act of 2012). The 2012 act substantially changed a number of laws to make it easier to solicit capital for emerging businesses, thus broadening the use of crowdfunding in this area.
What does the IRS have to say?
Information letter 2016-0036 was written in response to a taxpayer receiving crowdfunding contributions to buy a business. The taxpayer questioned the tax consequences of this, which the IRS concluded depend wholly on the facts and circumstances surrounding the crowdfunding effort. Unless crowdfunding revenues are structured as loans, gifts, or capital contributions (in exchange for equity interests), revenues are includible in taxable income.
Crowdfunding contributions are generally included in income under IRC Section 61. There are income exclusions under the Code, so depending on how the arrangement is structured, contributions might be excluded.
- Loans- Though crowdfunding contributions structured as loans are typically excludable from income, the arrangement should have sufficient debt-like features, like a fixed interest rate and ‘unconditional promise to pay’ in order to not be questioned by the IRS.
- Gifts- Under IRC Section 102, crowdfunding contributions structured as gifts for federal tax purposes are excluded from the recipient’s income. The donor might be subject to gift tax depending on the amount of the contribution (remember the $14,000 per person gift tax exclusion or lifetime exemption amounts). Conversely, “gifts” to IRS recognized charities are not subject to gift tax and may be deductible as a donation.
- Capital Contributions- Funds structured as capital contributions where the investor receives an equity interest would not be recognized as income by the recipient/investee company. It is important that the investor would clearly share in the risks and rewards of an ownership interest.
Important reporting responsibility
So, you may be questioning if crowdfunding contributions are reported to the IRS? Under IRC Sec. 6050W, payment settlement entities are required to annually report the gross payment amounts made to settle credit, debit and other card transactions on Form 1099K. If the payments to the payee are under $20,000, or there are fewer than 200 transactions with the payee inside of the calendar year, third-party payers (aka crowdfunding platforms) may be exempt from filing Form 1099K.
Wondering if you are required to report crowdfunding contributions? Contact me or any member of our Tax Services Team.