How are crowdfunding proceeds taxed?
13 November 2017
Crowdfunding is the practice of funding a project by gathering contributions (typically done via the internet) from a large group of persons. It has become a popular way to raise capital for a wide variety of projects from community development to the arts to technology.
There are three distinct types of crowdfunding—
- Reward-based crowdfunding: Businesses and non-profits of all sizes post projects on a crowdfunding portal, targeting a certain amount of capital to raise. In return for a donation from fans of a project, the business or non-profit typically gives some type of incentive for participating.
- Donation-based crowdfunding: Individuals donate money to a cause, charity or person without expecting anything in return other than the satisfaction of having contributed towards something they feel is worthwhile.
- Equity-based crowdfunding(also known as regulation crowdfunding): Equity crowdfunding is the process whereby people invest in an early-stage unlisted company(a company that is not listed on a stock market) in exchange for shares in that company.
Under general U.S. income tax principles, gross income includes “all income from whatever source derived,” except as otherwise provided. This definition is construed broadly and extends to all accessions to wealth over which the taxpayer has complete control. Any receipt of funds or property by a taxpayer is presumed to be gross income, unless the taxpayer can demonstrate the income fits into an exclusion.
While the IRS and Congress have not issued vast guidance on this issue, it appears that crowdfunding revenues generally are includible in income if they are not(1) loans that must be repaid, (2) capital contributed to an entity in exchange for an equity interest in the entity, or (3) gifts made out of detached generosity and without any quid pro quo.
Thus, there is the potential for donation-based crowdfunding (as a gift) and equity-based crowdfunding (as capital contributed in exchange for an equity interest in an entity) to be non-taxable. But amounts received through reward-based crowdfunding are usually taxable. Assuming that the crowdfunding activity is a trade or business and not a hobby, any expenses are deductible against income raised. However, if the expenses are categorized as start-up costs, the taxpayer must capitalize these costs unless an election is made to expense a portion of the costs.
Author: CJ Stroh, HLB USA, Withum
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