One of the new ways to raise money is through crowdfunding, which involves asking a large number of people to contribute money to fund a cause or activity. This is typically done via the Internet, using a third-party intermediary. Crowdfunding campaigns include donations to charity, raising money for personal expenses, funding a specific project or raising debt or equity capital for a new business.
Crowdfunding Models. Crowdfunding campaigns can typically be broken into the following models: 1) donation; 2) incentive; 3) purchase; 4) loan; and 5) ownership. Under the donation model, a payor gets (and expects) nothing in return for a payment. Under the incentive model, a payor expects something in return for a payment, which incentive generally increases based on the payment size. Under the purchase model, a payor will expect a product to be produced with their payment and will expect that product to be delivered at completion. The loan model involves just that – a loan to an individual or business. Finally, the ownership model gives the payor a percentage interest in a business. If your client wishes to fund its business using the ownership model, we recommend that you consult with us to review the securities law implications of such funding (in addition to the tax implications). Special rules, created by the SEC for crowdfunding, may or may not apply.
IRS Position. While crowdfunding is new, the IRS has issued an information letter concerning the tax implications of crowdfunding. The IRS noted that revenues raised via crowdfunding often constitute gross income to the recipient unless they are: 1) loans that must be repaid; 2) capital contributions for a percentage ownership in a business; or 3) a gift.
To constitute a gift for income tax purposes, the payor must be making the payment out of detached generosity and without an expectation of benefit. This may disqualify some or all of the payment under the incentive model from being a gift. In addition, the IRS has confirmed that a voluntary crowdfunding payment, even without a quid pro quo, is not necessarily a gift for income tax purposes. So, with respect to crowdfunding payments, it is important to understand the particulars of the arrangement and analyze whether that payment is a gift or income for tax purposes.
Tax preparers should also be mindful that a donation made via crowdfunding to a specific person probably does not qualify for a charitable deduction. Careful review of the facts are important here too.
Watch Out For Constructive Receipt. There are also tax issues from the receipt of the funds. The IRS’ constructive receipt regulation specifies that income is deemed to be received for tax purposes, even if not actually received, if it is credited to a taxpayer, set apart for the taxpayer, or otherwise made available to the taxpayer so that he or she may draw upon it at any time. This could cause certain cash from a crowdfunding campaign to be taxable to a taxpayer even if the cash is not actually received by the taxpayer.
Summary. While it appears here to stay, crowdfunding can have significant tax implications that recipients do not expect. A crowdfunding campaign should be carefully analyzed to determine those implications and potentially avoid an unexpected tax result. If you’d like to discuss the implications of a crowdfunding campaign further, please contact a member of the McGrath North Tax Group.