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.”