Posted by Marcelo Morinigo
Crowdfunding has increasingly gained popularity among entrepreneurs as more individuals and businesses comprehend the value derived from an early introduction of their products to the market. These benefits range from the ability to make an initial assessment of the public’s perception of the product, price sensitivity analysis based on contributions received and timing of these contributions, demographic acceptance, general feedback from product supporters, and of course, the most desired benefit during this stage: initial funding. A critical aspect for consideration and planning is the tax consequences of receiving money through crowdfunding.
Crowdfunding is defined as the practice of funding a project by collecting contributions from individuals called “backers” or “pledgers” through online platforms. The number of backers who can show their support and contribute towards the funding of each project is immeasurable. Some projects have many backers who pledge only a few dollars, whereas other projects only have a few backers who make larger contributions.
Crowdfunding was first used by artists and other creative individuals for small projects that would hardly be chosen by investors as an option due to their slim chances of success. Fast-forwarding to the 21st century, this practice has expanded to the point that it has become an attractive alternative to venture capital for pretty much any entrepreneur looking for seed capital. Websites such as Kickstarter.com and Indiegogo.com allow anyone with online access and a desire to contribute towards a project or endeavor of his or her interest to make someone’s idea or dream a reality.
As crowdfunding continues to increase the balances of individuals’ and businesses’ bank accounts, the question about how to properly account for this inflow of capital from a tax standpoint has become increasingly necessary. Merely calling crowdfunding income a “donation” or “pledged funds” does not mean all funds received through these channels are free of tax to the recipient. Kickstarter and other crowdfunding sites briefly address tax implications of receiving funding through their platform. However, information found on these websites is very broad in nature and should only be used as the starting point of a more thorough research effort based on specific facts and circumstances.
Section 61(a) of the Internal Revenue Code states that gross income includes all income from whatever source derived. Gross income includes all accessions of wealth, whether realized in the form of cash, property, or other economic benefit. However, certain benefits received are excludable from income, either because they do not meet the definition of gross income or because the law provides a specific exclusion for certain benefits that Congress chooses not to tax.
In general, in the U.S., money raised through crowdfunding is considered income. However, certain funds might be considered a nontaxable gift. It’s important to clarify that gift treatment would be disallowed where the reward has a value approximately equal to or greater than the contribution in return for the payment. On the other hand, money received without an offsetting liability, which is neither a capital contribution nor a gift, is includable in income.
With this concept in mind, funds gathered through crowdfunding efforts are generally included in income if they are not:
- A liability to the recipient, such as a loan or note payable,
- Equity contribution, such as an acquisition of shares of common or preferred stock in the enterprise, or
- Gifts made out of detached generosity and without a favor or advantage granted or expected in return.
The tax consequences of income from crowdfunding sources will depend on all facts and circumstances surrounding that effort. Many brilliant minds around the globe have and will continue to benefit from the beauty of crowdfunding. After a successful crowdfunding campaign ends, it’s time to put the tax hat on and start planning and preparing. Please contact one of our tax advisors for questions and/or assistance with regard to taxability of crowdfunding income.