Taxation and Crowdfunding
Small businesses raised $16 billion through crowdfunding in 2014, and 2015 showed those numbers almost doubling that mark. When that kind of money changes hands, the IRS takes notice. Do you need to pay taxes on crowdfunding, or are the contributions you receive considered as gifts?
What Is Form 1099-K?
Most small businesses never even think about taxes on crowdfunding until they get 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 prepare to provide supporting documentation.
What kind of income is crowdfunding? There are three common schools of thought when it comes to crowdfunding income: Charitable Donation, Gifts and Taxable Income.
Only crowdfunding campaigns that are truly charitable count as donations, such as campaigns to pay a person's medical bills or requests for donations by a registered nonprofit organization. It's unlikely that a 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 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 problem 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. Typically, a campaign sets minimum donations to receive a first-run 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 contributor received something to be sales and contributions where the contributor received nothing to be gifts.
What About Sales Tax?
When contributors receive something of value, sales taxes may also apply. Consider the following questions:
- Is the product or service the contributor receives something that's 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?
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.