Your Crowdfunding May Trigger a Taxable Surprise: 2022: Articles: Resources: CLA (CliftonLarsonAllen)

key ideas

  • The IRS position is that crowdfunding proceeds are included in gross income, unless otherwise excepted under federal income tax law.
  • The ultimate tax treatment of a crowdfunding transaction will depend on the facts and circumstances underlying a specific case.
  • Rewards-based crowdfunding raises multiple tax questions about valuation, deductions, and compensation products.

You may have already seen it. Someone shares a social media post asking for financial support, whether it’s to help pay for medical bills, fund a personal project, or something in between. It’s called crowdfunding – a modern approach to raising capital by collecting donations from people via online platforms. Yet this simple practice can raise complex tax issues for the recipient, and the final tax treatment may vary depending on how the proceeds were derived.

In 2016, the IRS released guidance on how to approach the federal tax treatment of crowdfunding proceeds. Review a few key points that could help your crowdfunding project stay compliant.

Are crowdfunding revenues included?

As a starting point, the IRS position is that crowdfunding proceeds are included in gross income, unless otherwise excluded under federal income tax law. The IRS clarifies by stating that crowdfunding income is generally included in income if it is not:

  1. Loans that need to be repaid
  2. Capital contributed to an entity in exchange for an equity interest in the entity
  3. Gifts made of detached and unrequited generosity

Of course, the ultimate tax treatment of a transaction will depend on the facts and circumstances of a specific case, such as whether the taxpayer was granted access to funds and any actual or self-imposed restrictions on that access.

Potential exceptions to the rule

While the thought process outlined by the IRS may seem straightforward, applying these guidelines to real-world transactions is more difficult.

For example, donation-based crowdfunding is the traditional function of fundraising – which provides no financial return to contributors. At first glance, it appears that the recipient could exclude the proceeds from gross income on the theory that the amounts received constitute gifts.

Nevertheless, the IRS may challenge this position if the recipient uses the proceeds to fund a project whose output could be used by the donor (e.g., online music), or if the recipient is unable to identify an anonymous donor to establish “intent” in an audit investigation.

Tax challenges for rewards-based crowdfunding

Similarly, in rewards-based crowdfunding, the recipient agrees to issue a product, service, or other token of appreciation to the donor in exchange for a cash contribution. This type of transaction raises multiple tax issues:

  • How to measure the consideration transferred to the donor
  • If the beneficiary can deduct the consideration so transferred
  • If the recipient can offset the crowdfunding proceeds (i.e. gross income) and the donor’s consideration (i.e. deductions) in the same year for purposes of calculating its federal taxable income and its tax obligations

How can we help you

The federal tax treatment of crowdfunding transactions is uncertain and requires careful analysis of the details of any given transaction. This is one of many “digital economy” transactions that should be reviewed by trusted tax advisors. Our team of professionals can assist you throughout the tax return preparation and planning process to help you file your return with confidence.

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