When you start a small business, often you will need to raise money to help get the company off the ground. There are several ways to raise these funds and one that is frequently overlooked is crowdfunding.
According to "Fundly.com"—a crowdfunding provider that works with people and organizations around the globe—US$34 billion is raised globally through crowdfunding. Of this amount:
- $25 billion came from peer to peer lending for small business projects
- $5.5 billion came donation to live event causes
- $2.5 billion came in the exchange for small business equity
Fundly states the average successful crowdfunded project raises $7,000 with the average donation being $88. When that kind of money changes hands, the Internal Revenue Service (IRS) takes notice. So as you begin to consider using crowdfunding to finance that new company you are building you need to also take into consideration the impact it could make on your tax burden.
With Crowdfunding, you are receiving one of three common types of income, a charitable donation, a gift, or taxable income.
Only crowdfunding campaigns that are truly charitable count as donations. Such campaigns include those that help to raise funds to pay for a person's medical bills or requests for donations by a registered nonprofit organization. It's unlikely that a Crowdfunding contribution to a business is ever legally a "donation."
Most small businesses think of their crowdfunding revenue as gifts. The reasoning is that contributors don't receive stock or expect repayment, so they are simply making a monetary gift out of goodwill. When that is true, the gift tax rules apply, and the amounts contributed to crowdfunding campaigns are generally below the threshold where gifts become taxable.
The IRS list that gifts are transfers of money or the equivalent where no consideration was given in return. Usually, the giver pays any gift tax, and as long as the money does not exceed the annual gift tax exclusion—which is $15,000 for 2018 and 2019—it is not taxable.
However, the problem with Crowdfunding is that the contributors often do receive something of value in return for their contribution, so it cannot legally fall into the gift category.
When a contributor receives something of value, the contribution becomes taxable income. Often, a funding campaign will set minimum donations and the giver will receive a first-run of the product or a gift certificate valid when the product launches. In those cases, the crowdfunding contribution is technically no different than a sale in an online store or at the cash register.
There may be an argument for dividing the contribution into partially a gift and partially a sale, like when a charity sells items above market value. The market value of the item counts as a sale, and the remaining amount becomes a donation to the charity.
The problem in the crowdfunding context is that the IRS is likely to view it as purely a business transaction. Any difference in value could be either a discount or an early adopter's premium and not a gift. A safe choice might be to consider contributions where the donor received something to be sales and contributions where the patron received nothing be classified as gifts.
What About State Sales Tax?
When contributors receive something of value, state sales taxes may also apply. Consider the following questions:
- Is the product or service the contributor receives something that is subject to sales tax in your state?
- Are you required to collect sales tax for online purchases by out-of-state residents?
- Do you have connections to another state that might require you to collect sales tax on purchases shipped to that state?
- Does that state subject the product or service to sales tax?
Receiving Form 1099-K
Most small businesses never even think about taxes on crowdfunding until they get IRS Form 1099-K in the mail. A 1099-K is not a determination that you earned income. It simply reports that you had 200 or more transactions netting a total of $20,000 or more through the electronic-payment processor that issued the form.
The purpose of Form 1099-K is to keep online-auction sellers and other small businesses from evading taxes on transactions that previously went under the radar. If your crowdfunding income is not taxable, you do not need to pay tax on the amount reported on Form 1099-K. The IRS will likely request additional information about why the income wasn't taxable though, so be prepared to provide supporting documentation.
Talk to Professional Accounts
Remember that because state and federal laws are different, the determination for whether you pay sales tax, federal income tax, and state income tax are three separate questions. You should seek appropriate professional guidance through official bookkeeping services for each of those questions.
To be safe, get help keeping track of your crowdfunding revenue with qualified online accounting services. It may mean support in managing receipts and invoices, tracking commissionable sales, or otherwise filing the appropriate forms and reports to ensure you stay on the right side of tax rules and bookkeeping procedures.
The information contained in this article is not tax advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax advice, please consult with an accountant.