Crowdfunding taxes: Why entrepreneurs may owe the IRS
4 min read
February 08, 2021 • Block Advisors
Raising money online through third-party backers, or crowdfunding, is an emerging and widespread way to raise capital as a small business.
Why is it gaining popularity? Crowdfunding is often an easier alternative for aspiring entrepreneurs to quickly get some cash. But, while this method has perks compared to conventional fundraising, it’s important to know crowdfunding taxes are not a group responsibility. In fact, they’re probably yours.
It’s clear that business owners who organize campaigns like these should report the income as business income. And if you’re on the giving end of the funds, more often than not it’s not a charitable deduction. Read on for details…
How crowdfunding got started
The alternative financing option emerged in the early 2000s. In its infancy, these crowdfunding sites were gamified – that is they set a fundraising goal, and if that goal was not reached, they would get a refund for their original donation. Today, they look a bit different, but have the same goal – to raise money.
It’s easy to see why business owners would find this type of funding attractive, especially if they are just starting a business.
Is crowdfunding taxable income?
You may wonder “Is crowdfunding taxable income in the eyes of the IRS?”
Crowdfunding taxes are still a grey area. So far, the IRS has not addressed how taxpayers should treat crowdfunding on their tax returns. Without official guidance, the proper tax treatment likely hinges on two factors:
- The campaign organizer’s intent and situation, and
- Whether backers receive or will receive goods, services, or an ownership interest in exchange for their contributions.
Although the funds may come in through a single platform, tax implications can be surprising for those who think each donation is one in the same.
Crowdfunding taxable income considerations
There are a few potential points you’ll want to read up on if you’ve taken funds via crowdfunding to help get your small business going.
1 – 1099-K, for third-party network transactions
Crowdfunding websites will often issue a Form 1099-K, Payment Card and Third Party Network Transactions, to the campaign organizer receiving the funds.
How taxpayers should report the amount on this form on their tax returns varies depending on the nature of the payment.
If you’re not sure if you should report the income, it’s best to err on the side of caution: Since the IRS implemented the Form 1099-K, they have sent more notices to taxpayers who received the Form 1099-K but didn’t report the income on their tax returns.
One thing is pretty clear: If a campaign organizer’s intent is to generate funds in exchange for goods or services, and if viewed outside the context of the crowdfunding website was seen as such, the raised funds should be considered taxable business income, under Internal Revenue Code § 61(a).
Don’t want to tackle handling Form 1099-K or other tax forms alone? Get help with your small business taxes from the team at Block Advisors.
2 – Are crowdfunding donations taxable if they are charitable deductions?
Contributions for individuals or organizations that aren’t qualified charitable organizations, such as §501(c)(3) entities, will not qualify as deductible charitable contributions, regardless of the circumstances. Taxpayers can deduct charitable contributions only when they’re made to qualified charitable organizations not intended to benefit specific individuals.
3 – The gift tax limit
A contribution to an individual’s crowdfunding campaign that is a gift and doesn’t qualify for a charitable deduction may be subject to gift tax rules if it’s more than $15,000 – the annual gift-tax exclusion limit per individual. If your small business has a generous supporter who contributes that amount or more than that amount in a given year, they also may have to file a gift tax return. Business owners should be aware of the legal implications created when new owners contribute significant amounts money to a venture in exchange for stock or partnership rights.
4 – Is crowdfunding taxable when it’s used for life events?
Life event crowdfunding websites allow individuals to raise funds to cover the costs of various life events, such as a bucket-list trips or medical bills. These campaigns typically have no resemblance to business activities. Donors usually don’t receive anything in exchange for their contributions, thus the proceeds received are not considered taxable income.
More help with crowdfunding taxes
When it comes to crowdfunding, track and document any transactions made and report the contributions you receive. It’s especially important to track as a small business owner.
Remember, there is no doubt that tax can get complex, which is why you should lean on the support of an experienced tax pro. Our tax pros have the expertise to handle even the most complex tax situations. Hand off your taxes; we’ll do the work.
Find a tax pro now.