It has become fairly common these days for individuals and businesses to raise funds for various purposes through a mechanism referred to now as “crowdfunding.” Whether for a charitable cause such as a medical need or to raise funds for a start-up business, social media has made it easy to reach a broad range of people in order to request money for a cause.
To initiate a crowdfunding effort, the individual or entity generally enlists the assistance of an established platform, such as Kickstarter or GoFundMe. During the set-up process, the fund raiser will in most cases be asked to complete tax forms which will be provided to the IRS, such as a W-9 or W-8. At the conclusion of this effort, Form 1099-K will be issued from the payment processor to the platform, if certain thresholds are met, and a Form 1099-K may be issued to the fund raiser, if certain thresholds are met. At the end of the day, your client will come to you with the Form 1099-K and ask you why he received it, and now, how does this impact his tax obligations.
A determination on whether funds raised during this effort are taxable turns, of course, on the purpose of the effort. If the funds are raised in connection with a business start-up, or to determine the feasibility of a business venture, there may be tax consequences, depending on what consideration is given for the contribution. If the funds are contributed for a charitable cause, taxability depends on the amount of the contribution, and to whom the funds were given. In certain circumstances, funds may be contributed directly to a certified charitable organization on behalf of an individual, which may result in a contribution deduction for the donor, and no impact on the individual.
There is little IRS guidance available specifically on the issue of taxability of funds received though crowdfunding. The IRS did issue Information Letter 2016-36 (IL) in response to a taxpayer’s request for guidance in the business contribution arena. The IL generically refers to the general tax law principles of IRC §61: “Gross income includes all income from whatever source derived.” It goes on to say:
“In general, money received without an offsetting liability (such as a repayment obligation), that is neither a capital contribution to an entity in exchange for a capital interest in the entity nor a gift, is includible in income. The facts and circumstances of a particular situation must be considered to determine whether the money received in that situation is income. What that means is that crowdfunding revenues generally are includible in income if they are not 1) loans that must be repaid, 2) capital contributed to an entity in exchange for an equity interest in the entity, or 3) gifts made out of detached generosity and without any “quid pro quo.” However, a voluntary transfer without a “quid pro quo” is not necessarily a gift for federal income tax purposes. In addition, crowdfunding revenues must generally be included in income to the extent they are received for services rendered or are gains from the sale of property.”
So generally, if the funds raised are for a charitable purpose such as a medical need, funeral, or other personal need of an individual or family, there are no tax consequences if the individual “gifts” are below the IRS threshold for the gift tax annual exclusion. In these cases, the contributor expects nothing in return for his contribution.
If funds raised, for example, are for a start-up business, and the contributor receives an equity interest in the enterprise, the funds may be treated as a capital contribution. If the contributor receives something in exchange for the funds, there will likely be income tax consequences, as well as state sales tax consequences for the fund raiser. These situations most commonly arise in connection with test marketing a product through a crowdfunding platform.
The issuance of Form 1099-K as a result of the type of revenue generating activity discussed above is governed by IRC §6050W, “Returns relating to payments made in settlement of payment card and third party network transactions.” A Form 1099-K must be filed under the following circumstances: “A payment settlement entity (PSE) must file Form 1099-K for payments made in settlement of reportable payment transactions for each calendar year. A PSE makes a payment in settlement of a reportable payment transaction, that is, any payment card or third party network transaction, if the PSE submits the instruction to transfer funds to the account of the participating payee to settle the reportable payment transaction.” irs.gov.
It is apparent that there are a myriad of scenarios surrounding crowdfunding activities, and the potential tax implications of these activities. This note only scratches the surface of the various ways people are trying to raise money on-line through the use of social media, using different platforms that make it easy to do so. It may be advantageous to add as a best practice, at a minimum to any business client questionnaire, whether they engage in on-line crowdfunding. It is important to secure the specific facts surrounding the activity to use as a guide as you determine any tax consequences of such activity, how to handle your client’s Form 1099-R, and also in advising clients who are contemplating fund raising of this type. This issue is of growing importance in the area of taxability of on-line transactions, and we will look for more guidance from the IRS, as well as state tax agencies for sales tax implications, on handling these transactions in the months to come.
Kathleen M. Lach is a Partner in the Tax and Litigation Departments of Arnstein & Lehr LLP. She represents clients before a variety of different tax authorities, including the Internal Revenue Service, the Illinois Department of Revenue, and the Illinois Department of Employment Security.