Monday, June 29, 2015

Some Federal Tax Issues Associated With Crowdfunding

Crowdfunding has become a popular way to raise capital in a broad range of fields. 

The tax treatment of the contributions is not always clear, and the IRS has yet to directly rule on the subject.

This blog post examines a number of the federal tax questions that may arise for both the contributor and the recipient. 

Background. Crowdfunding is a way, typically on the Internet, for individuals and entities to tap into communal funding for a wide variety of projects, from community development to supporting artist and software innovation. Initially, crowdfunding was largely used by musicians, film makers, and other creative types to raise small sums of money for projects that likely wouldn't make money. But, while still a relatively new way to raise funds, its impact is growing—in some cases, becoming an alternative to venture capital.

While crowdfunding allows an entrepreneur to obtain proceeds for a specific project, what those giving the money get varies considerably depending on how the program is structured. Sometimes those contributing to a crowdfund get absolutely nothing in return except the personal satisfaction of helping launch a cause or participate in creating an innovation that they believe in. Often those contributing or pledging to a campaign are offered "rewards" such as cups with logo, tee shirts, tickets to an event, or CDs. Or they might receive the right to have their contribution repaid with interest if the campaign is financially successful. Or they might receive an equity interest in the endeavor, i.e., a piece of the future profits.

Are contributions reported to IRS? The first question that might be asked is whether IRS tracks such crowdfunding payments. Code Sec. 6050W requires information reporting for certain payments made in settlement of payment card (e.g., a credit card) and third party network transactions (e.g., PayPal). Thus, any payment settlement entity making payment to a participating payee in settlement of reportable payment transactions (generally, any payment card transaction and any third party network transaction) must make a return for each calendar year to be filed with IRS, and furnish a statement to the participating payee (Form 1099-K), that sets out the gross amount of the reportable payment transactions as well as the name, address, and taxpayer identification number (TIN) of the participating payees. However, a de minimis rule exempts a third party from reporting of third party network transactions of any participating payee if the aggregate payments to the payee by the third party for the calendar year do not exceed $ 20,000 or if the aggregate number of transactions between the third party and the payee that would otherwise be reportable does not exceed 200 within the calendar year.
Are the contributions income to the recipient? Code Sec. 61(a)(1) defines gross income as "all income from whatever source derived." This definition is construed broadly and extends to all accessions to wealth over which the taxpayer has complete control. As the Supreme Court explained, a gain "constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it." (Commissioner v. Glenshaw Glass Co., (Sup Ct 1955) 47 AFTR 16247 AFTR 162)

  • Thus, any receipt of funds or property by a taxpayer—such as crowdfunding contributions—is presumed to be gross income unless the taxpayer can demonstrate that the income fits into one of the narrowly construed exclusions provided by law. One of those exceptions is where the amount received was a gift.
Are amounts received by the recipient a nontaxable gift? Under Code Sec. 102, the value of property acquired by gift is excluded from the recipient's gross income. Under the Supreme Court's well known holding in Comm. v. Duberstein, (S Ct, 1960) 5 AFTR 2d 16265 AFTR 2d 1626, the value of property acquired by gift is excluded if it: comes from a detached and disinterested generosity; is made out of affection, respect, admiration, charity or like impulses; is not made from any moral or legal duty, nor from the incentive of anticipated benefit of an economic nature; and is not in return for services rendered. Recipients may exclude payments that they receive under Code Sec. 102 if they meet the Duberstein standard.

  • Thus, on one side of the spectrum are payments made without the donor receiving an economic or other consideration, while on the other are payments from ordinary business or commercial transactions. Accordingly, if there is a quid pro quo in which the donor receives a tangible economic benefit in return for his contribution, then there isn't a gift. 
  • RIA observation: If the donor receives a particular "reward" for his contribution, does he receive an economic incentive that would negate a gift? Or is the benefit that the donor receives so inconsequential or insubstantial as to be ignored? While not strictly applicable, the rules on when a donor making a contribution to a tax-exempt charity can receive a benefit and still deduct the contribution in full may be helpful. They apply when: (1) the fair market value (FMV) of all benefits received in connection with the contribution isn't more than 2% of the contribution, or $105 for 2015, if less; or (2) the contribution is at least $52.50 for 2015, and in connection with it the donor receives only token benefits (bookmarks, calendars, mugs, posters, tee shirts, etc.) generally costing no more than $10.50 for 2015; or (3) the charity mails or otherwise distributes free, unordered items to patrons.
 Other Questions Include:
Are amounts given subject to the gift tax?

Can expenses in a crowdfunded project be deducted?
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