Crowdfunding: Cash From The Masses

Straight to the people. Broaden the base. Get new players involved. No, it’s not a political campaign strategy session. It’s the premise behind a new and creative way of raising cash that’s gaining a lot of traction: crowdfunding.  Here, money is raised by gathering contributions online from a large group of backers for a particular project.

Social media has effectively utilized crowdfunding, but specialty web sites have embraced and perfected the model.  Some of the popular players in this young industry include Kickstarter, Indiegogo, RocketHub, GoFundMe, Causes and Snap-Raise.

What started as a way to raise funds for creative enterprises has now grown into a practice used for a variety of purposes – personal fundraising, charity fundraising, capital for companies, loans, and more. This fresh marketing approach has allowed anyone with a pitch to directly access new and larger target audiences. Many, but not all, crowdfunding campaigns require a certain fundraising goal be achieved before the donors actually part with the funds. This strategy allows the campaign to create “buzz” and momentum surrounding the project, and ensures that backers are only supporting successful ventures. Increasingly, businesses are looking at crowdfunding as an alternative to venture capital or traditional financing. Many crowdfunding campaigns offer backers a “reward” for participation, and these get pretty creative. Think, your name painted on a tractor, or a hot air balloon ride with the project’s famous chief innovator.

How do we know it’s catching on? From a personal standpoint, I had three emails just today inviting me to join crowdfunding campaigns. One of them is near and dear to my heart – a joint project of Gate of Hope and Louisville Grows – to fund community-supported agriculture. But the stats reflect it too; the research firm MASSolution reports crowdfunding is expanding exponentially and globally as a new and creative way to raise cash, and not just for altruistic causes. Their latest report indicates a 167% increase, with total funds generated growing from 6.1 to 16.2 billion dollars, from 2013 to 2014.

This kind of success is sure to be noticed by taxing and regulatory agencies. The SEC addressed equity-based crowdfunding earlier this year. And although there are not yet any tax cases or IRS rulings, the IRS did issue an Information Letter on the topic recently. To date, only a few states have definitively outlined their positions, but their radar will be focused on both income and sales taxes.

So, what did the IRS say about taxing crowdfunding revenues in their Information Letter?  Short answer: “it depends.” Long answer: whether the income is taxable depends on the facts and circumstances surrounding the particular campaign. They further elaborated that these revenues will generally be taxable income if they are for services rendered or are gains from selling property, and unless they

  1. Must be repaid (loans);
  2. Were capital contributed in exchange for an equity interest; or
  3. Were gifts without an expectation of a “quid pro quo” (as gift is defined pursuant to Code Section 102).

Other tax considerations should be contemplated by clients wishing to launch a crowdfunding campaign:

  1. Which expenses are deductible against the revenues?
  2. How to value rewards provided to backers?
  3. Will some expenses be considered start-up costs or organizational costs?
  4. Which accounting method is favorable, given the timing of receipts versus expenses?
  5. To what extent are donors eligible for charitable contribution deductions?
  6. Are amounts given subject to the federal gift tax?

With the possible exception of equity-based crowdfunding, the web sites generally use an outside party like PayPal for processing payments. These processors comply with the IRS’s information reporting requirements pursuant to Code Section 6050W. A campaign collecting over $20,000 and having over 200 transactions in a year will be given a Form 1099-K, indicating its gross receipts for the year. As with all IRS information reporting, the reported amount will be matched to the taxpayer’s return after it is filed for that year, to ensure the income is reported.

In the past five years, crowdfunding has jettisoned from “huh?” to household word.  Its phenomenal growth will no doubt continue to be fueled by cash-seekers’ endlessly creative applications. Clients wishing to take advantage of this business model should discuss the tax implications at the outset with their DMLO advisor so that their business structure and reporting systems can support their project in the most tax-efficient manner.

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