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Understanding the Tax Consequences of Crowdfunding

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How many of us have been on social media and read a plea to financially support someone’s medical issue or their new startup business? This fast-growing method of raising funds is called crowdfunding. There are essentially 3 different types of crowdfunding: crowdfunding for equity interests, donation-based crowdfunding, and reward-based crowdfunding. What are the tax consequences to the recipients of these funds? The IRS has done very little to issue guidance on this new fund raising mechanism so we need to look at existing rules for tax implications.

Equity-only crowd-based funding is fairly straightforward from a tax perspective, but likely raises concern with the Securities and Exchange Commission (SEC). From a tax perspective, if you take money in exchange for stock/ownership interest, the contribution of money to the company will likely be tax free and will add to the capital of the company. It is important to know that you may have SEC issues by raising capital in this manner and it would be important to ensure you follow the applicable guidance.

The crowdfunding mechanism perhaps seen most on social media is donation-based crowdfunding. This is a circumstance when an individual or charity is attempting to raise money for a particular cause. GoFundMe and Razoo are common avenues for these types of contributions. Contributions of this nature to an individual would typically be categorized as a nontaxable gift. Gifts are generally defined for federal income tax purposes as an amount transferred out of detached and disinterested generosity. If the money goes to a qualified charity (501(c)(3)), the charity would have donation income and presumably the donor would have a charitable contribution on their return. Donations made to non-qualified organizations or individuals are not deductible as charitable contributions.

Reward-based crowdfunding is the last form of crowdfunding covered in this article. Reward-based crowdfunding is when a company raises capital by promising rewards (product, merchandise, or experiences) in exchange for contributions – which the company uses to fund the startup of the company or a product line.  Think Kickstarter as an example. Presumably, the receipt of these monies by the company would in fact be revenue to the company and the resulting income may not be offset by any current expenses. If a business is in a startup phase, expenses of the businesses are typically capitalized and expensed once business commences. This could create a mismatch between income and expenses if income is recognized in one year and the expenses in a following year.

If you have any questions regarding crowdfunding please contact our office and we would be pleased to discuss the matter further with you.