Crowd funding presents a new area of tax planning expertise

Fund recipients, entrepreneurs could use a bit of guidance

Jan 30, 2013 @ 3:24 pm

By Darla Mercado

Crowd funding is forecast to grow in popularity this year, leading to an added demand for specialized tax advice.

The latest evolution in “passing the hat,” crowd-funding portals allow people to help back a project or a burgeoning company by providing financial contributions on the web. There's also a philanthropic twist to crowd funding in which individuals and groups can donate to charitable causes or raise money for people who need help covering medical expenses through sites like GoFundMe.com.

Deloitte LLP predicts that this year, crowdfunding portals will raise some $3 billion, up from $1.5 billion in 2011.

But there are potential tax traps for unwary individuals who hope to obtain some funding through the web, and experts warn that the issue of whether a recipient's small windfall is considered a gift or income could be a gray area.

“There are criteria that the [Internal Revenue Service] looks at to see if the funds are a gift or if they're something else,” warned David White, a certified public accountant and member of the American Institute of CPA's Trust, Estate and Gift Tax technical research panel. “You could have an auditor come in and make a determination. Unfortunately, with the IRS, they can assess you and you'll have to defend yourself.”

In the best of all scenarios, the entity soliciting funding on the web is a tax-exempt nonprofit organization or a religious entity which can receive donations that are tax-deductible to the giver.

However, solicitors in crowd funding could also be individuals or other groups that aren't tax-exempt — say, an entrepreneur looking to start a business venture or a starving artist.

When it comes to giving money to an individual, money that's a true gift isn't tax-deductible to the donor. In fact, the giver may have to pay a gift tax if the donation is large enough. This year, donors can make a tax-exempt gift to another individual of up to $14,000.

Funding that exceeds the annual exclusion may still be tax-free up to the lifetime estate basic exclusion amount, which is now $5.25 million, Mr. White said. Alternatively, donors can pay up the gift tax on money that exceeds $14,000 without affecting their lifetime estate basic exclusion amount, but the highest gift tax rate is 40%.

When it comes to recipients, however, entities that aren't tax-exempt can encounter a gray area: Is the money they're receiving considered a gift or income?

Money raised for a family that's recovering from a tragedy is generally viewed as a gift: The person giving the money doesn't get any tax deductibility from it and it's tax-free to the recipient.

“In a situation where there's a fire, and then a fundraiser for the family that's affected, the money is truly a gift,” Mr. White said. “The recipient gets it tax-free, and the donor may be subject to gift tax.”

However, in a situation where a nonexempt small business or an individual seeks funding to help release a product — such as a film — those donations could be considered taxable income, according to David Marlett, executive director of the National Crowdfunding Association.

In those situations, there are ways to offset that income, perhaps by giving donors in those situations a reward — such as a T-shirt — to count as an expense against the income received via the funding, he explained. Such presales allow companies to both raise funds and distribute products to donors. However, businesses may end up on the hook for state sales taxes for these so-called pre-sales, Mr. Marlett said.

Where the picture gets murky as to whether received funds are a gift or income is when an entrepreneur is soliciting donations to supplement his or her livelihood. An auditor for the IRS could very well deem the money to be income.

“Say you're an artist, and these donations are money for you to do your business and sell your art,” Mr. Marlett said. “That's tricky. It's a situational basis.”

0
Comments

What do you think?

View comments

Recommended for you

Upcoming Event

May 30

Conference

Adviser Compensation & Staffing Workshop

The InvestmentNews Research team will present exclusive data and highlights from its bellwether benchmarking study that will identify best practices for setting and structuring compensation and benefits packages throughout your... Learn more

Featured video

INTV

Behind the scenes of InvestmentNews' Best Places to Work

Benefits and vacation policies are important for hiring top talent, but giving employees a sense of ownership in decision-making is among the most important qualities, editor Fred Gabriel says.

Latest news & opinion

Why we must create a more diverse and sustainable financial planning profession

CEO explains how, why a firm should commit to conscious inclusion.

Pope Francis wants financial advisers to work like fiduciaries

Vatican bulletin admonishes advisers who act against the best interests of their clients.

Wells Fargo sees slowdown in advisers exiting this year

The 2016 banking scandal and public relations fiasco had alienated some of the firm's advisers.

States trying to save DOL fiduciary rule appeal rejection of effort to intervene

California, New York, Oregon ask for rehearing by full 5th Circuit Court of Appeals.

Employees at best places to work focus on the person — and the fun

Employees at best places to work firms focus on the person and fun.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print