Kickstarting the Right Way – The Taxation of Crowdfunding

Taxes on Crowdfunding? What You Need to Know…

While the IRS hasn’t issued final regulations on how crowdfunding arrangements should be taxed, they did offer guidelines that can be followed to make sure you stay on the right track.

First, what is crowdfunding?

Crowdfunding is a way for businesses and entrepreneurs to solicit online contributions directly from individuals, generally accomplished through a platform like Kickstarter or Angel.co. Contributors are often “rewarded” for their contributions, and rewards can range from trivial items like t-shirts or stickers to early access to the final product or service if and when it eventually becomes available. While these platforms were originally used primarily to fund small arts-related projects (like independent films or records) that were not profit-oriented, the userbase shifted towards profit-oriented endeavors after Title III of the 2012 JOBS Act created a federal exemption allowing companies to offer and sell securities through crowdfunding.

What do I need to know if my company is running a crowdfunding campaign?

Is crowdfunding income taxable?

Generally, crowdfunding contributions are includible in income (aka they are taxable), however, there are exceptions to this. The exceptions can be identified by matching the crowdfunding arrangement to the existing tax law to which it most closely relates. What does that mean?

  • Loans – If the company crowdsources funds from contributors that the company promises to repay, with interest and at a specific maturity date, the contributions can be treated like any other loan, and the contributions would not be includable in the recipient’s income
  • Gifts – Contributions made out of the contributor’s “detached and disinterested generosity” (they don’t get any economic benefit in return for their contribution) are not included in the recipient’s income
    • Do rewards given to contributors mean that the contribution can’t be treated as a gift? Not necessarily. There is no specific guidance provided on this topic, but the closest comparison to existing law is to the quid pro quo charitable donation limitations, which state that a benefit is de minimis (and therefore doesn’t change the character from that of a gift) if its value is less than 2% of the contribution and less than $106. That said, there is still a lot of gray area with regards to specific situations and circumstances
  • Capital Contributions – Contributions made in exchange for an ownership interest in the company are generally not taxable, as they would be treated like any other capital contribution (although some exceptions do exist)

Are crowdfunding expenses deductible?

There are two main questions to ask before determining how to treat crowdfunding expenses:

  • Is this a for-profit endeavor? Am I using crowdfunding to help start a bakery that I hope will one day support my family or am I raising money to fund a documentary that I don’t expect to turn a profit?
    1. If you answered ‘No’ (you’re filming the documentary, not opening the bakery), the expenses will be governed by the existing hobby-loss rules, which, among other things, force you to deduct the expenses as itemized deductions subject to the 2% limitation
    2. If you answered ‘Yes’ (you’re opening a bakery), move to question #2
  • Are these startup expenses or are they expenses related to the continuing operations of an existing business?
    1. If they are related to existing business, they can be deducted as ordinary expenses
    2. If they are startup expenses, they are subject to the startup cost limitations that any startup would be subject to. The limitation rules say that you can deduct $5,000 of startup expenses in the first year, and the rest are amortized over a 15-year period. Additionally, the $5,000 deduction is decreased (or phased out) dollar for dollar as your company’s total startup expenditures exceed $50,000

The long story short…

We don’t have a cut and dry response from the IRS as to the taxation of crowdfunding, however, with the guidance they have provided and an understanding of the existing tax code, we can make an educated guess as to what the IRS will likely challenge and what they will not. Thinking about running a crowdfunding campaign and not sure where you stand? Let us know, we can help!