Crowdfunding websites such as Kickstarter and GoFundMe have become an increasingly popular way for small business owners to stay afloat. The upside is that it’s often possible to raise the cash you need; the downside is that the IRS considers that money taxable income. Let’s take a closer look at how crowdfunding works and how it could affect your tax situation.
What is Crowdfunding?
Crowdfunding is the practice of funding a project by gathering online contributions from a large group of backers. It was initially used by musicians, filmmakers, and other creative types to raise small sums of money for projects that were unlikely to turn a profit. More recently, it has been used to fund projects, events, and products and, in some cases, has become an alternative to venture capital. However, with the onset of coronavirus, many struggling business owners have turned to crowdfunding to raise cash to continue operating their businesses.
There are three types of crowdfunding: donation-based, reward-based, and equity-based. Donation-based crowdfunding is when people donate to a cause, project, or event. GoFundMe is the most well-known example of donation-based crowdfunding, with pages typically set up by a friend or family member (“the agent”) such as to help someone (“the beneficiary”) pay for medical expenses, tuition, or natural disaster recovery.
Reward-based crowdfunding involves an exchange of goods and services for a monetary donation, whereas, in equity-based crowdfunding, donors receive equity for their contribution.
Are Crowdfunding Donations Taxable?
This is where it can get tricky. As the agent or person who set up the crowdfunding account, the money goes directly to you; however, you may or may not be the beneficiary of the funds. If you are both the agent and the beneficiary, you would be responsible for reporting this income. Suppose you are acting as “the agent” and establish that you are indeed acting as an agent for a beneficiary who is not yourself. In that case, the funds will be taxable to the beneficiary when paid – not to you, the agent. An easy way to circumvent this issue is to make sure when you are setting up a crowdfunding account such as GoFundMe; you designate whether you are setting up the campaign for yourself or someone else.
Again, as noted above, as the beneficiary, all income you receive, regardless of the source, is considered taxable income in the eyes of the IRS – including crowdfunding dollars. However, money donated or pledged without receiving something in return may be considered a “gift.” As such, the recipient does not pay any tax. Up to $16,000 per year per recipient in 2022 ($15,000 in 2021) may be given by the “gift giver.”
Let’s look at an example of reward-based crowdfunding. Say you develop a prototype for a product that looks promising. You run a Kickstarter campaign to raise additional funding, setting a goal of $20,000, and offer a small gift in the form of a t-shirt, cup with a logo, or a bumper sticker to your donors. Your campaign is more successful than you anticipated it would be, and you raised $35,000 – more than twice your goal.
Taxable sale Because you offered something (a gift or reward) in return for a payment pledge, it is considered a sale. As such, it may be subject to sales and use tax.
Taxable income Since you raised $35,000, that amount is considered taxable income. But even if you only raised $20,000 and offered no gift, the $20,000 is still considered taxable income and should be reported as such on your tax return even though you did not receive a Form 1099-K from a third-party payment processor (more about this below).
Generally, crowdfunding revenues are included in income as long as they are not:
- Loans that must be repaid;
- Capital contributed to an entity in exchange for an equity interest in the entity; or
- Gifts made out of detached generosity and without any “quid pro quo.” However, a voluntary transfer without a “quid pro quo” isn’t necessarily a gift for federal income tax purposes.
Income offset by business expenses You may not owe taxes however, if your crowdfunding campaign is deemed a trade or active business (and not a hobby) your business expenses may offset your tax liability.
Factors affecting which expenses could be deductible against crowdfunding income include whether the business is a startup and which accounting method (cash vs. accrual) you use for your funds. For example, suppose your business is a startup. In that case, you may qualify for additional tax benefits such as deducting startup costs or applying part or all of the research and development credit against payroll tax liability instead of income tax liability.
Timing of the crowdfunding campaign, receipt of funds, and when expenses are incurred also affect whether business expenses will offset taxable income in a given tax year. For instance, if your crowdfunding campaign ends in October but the project is delayed until January of the following year, it is likely that there will be few business expenses to offset the income received from the crowdfunding campaign since most expenses are incurred during or after project completion.
How Do I Report Funds on My Tax Return?
Typically, companies that issue third-party payment transactions such as Amazon if you use Kickstarter, PayPal if you use Indiegogo, or WePay if you use GoFundMe) are required to report payments that exceed a threshold amount of $600 in gross payments regardless of the number of transactions or donations. Prior to 2022, the threshold for a crowdfunding website or payment processor to file and furnish a Form 1099-K, Payment Card and Third Party Network Transactions, was met if, during a calendar year, the total of all payments distributed to a person exceeded $20,000 in gross payments resulting from more than 200 transactions or donations.
Form 1099-K includes the gross amount of all reportable payment transactions and is sent to the taxpayer by January 31 if payments were received in the prior calendar year. Include the amount found on your Form 1099-K when figuring your income on your tax return; generally, Schedule C, Profit or Loss from Business for most small business owners.
The American Rescue Plan Act (ARPA) of 2021 clarified that the crowdfunding website or its payment processor is not required to file Form 1099-K with the IRS or furnish it to the person to whom the distributions are made if the contributors to the crowdfunding campaign do not receive goods or services for their contributions. As such, it is important to keep complete and accurate records of transactions relating to your crowdfunding campaign, including a screenshot of the crowdfunding campaign for at least three years (it could be several years before the IRS “catches up”) as well as documentation of any money transfers.
Seek Professional Tax Advice
If you’re thinking of using crowdfunding to raise money for your small business, it may be prudent to consult a tax and accounting professional who will evaluate your tax situation and help you figure out a course of action to help your small business succeed. Contact us today!