Do You Have to Pay Income Tax on Crowdfunded Money?
Does the IRS want a piece of your donations? Maybe
Crowdfunding is a booming trend. Asking others for a little financial help when you’re facing life’s more trying circumstances is nothing new, but the internet has put a whole new spin on the practice. Sites like GoFundMe, Kickstarter, GiveForward, and Crowdfunder make it possible to help others by simply tapping your phone. In fact, since its inception, GoFundMe has reportedly had over 50 million donors give more than $5 billion.
Of course, the Internal Revenue Service (IRS) perks up whenever money changes hands, so it’s natural to ask: Do you have to pay taxes on this money when it starts pouring in? It all depends on whether the money is given to you out of the goodness of someone’s heart or because you provided something in exchange.
The IRS and Crowdfunding
The IRS didn’t really get around to addressing the issue of crowdfunding until 2016 when it issued Information Letter 2016-0036. Provisions for crowdfunded money aren’t yet explicitly cited in the Internal Revenue Code (IRC). It comes down to an interpretation of other IRC rules.
Basically, donations are taxable income if donors receive something in exchange for their generosity. Otherwise, they’re non-taxable gifts—at least if you’re a private individual and not a business.
The general rule is that the crowdfunding website must report distributions made to the organizer of the crowdfunding campaign—who then presumably turns the money over to the campaign’s beneficiary—on IRS Form 1099-K. Both the IRS and the organizer receive a copy of the form if more than $20,000 is involved and more than 200 transactions were made during the calendar year.
Receiving a 1099-K doesn’t automatically mean the funds are reportable as income or that the money will be taxed. It comes down to the nature of the fundraising campaign.
When the Money Is a Gift
There’s fundraising—and then there’s fundraising. For example, maybe Joe and Mary lost their home and possessions after a catastrophic home fire. They have two young children and don’t know where to turn because insurance won’t cover the full extent of their losses or medical expenses.
Mary’s sister steps in and sets up a crowdfunding account to help the family. She raises $30,000 from 201 people, exceeding the 1099-K requirements, and she receives a copy of the form from the crowdfunding platform or its payment processor. Does Mary’s sister owe taxes on that $30,000? Do Joe and Mary owe the taxes?
Assuming that Joe, Mary, and her sister didn’t give any of these 201 people anything in exchange for their money, the $30,000 can be considered a gift and is therefore not subject to taxes paid by the receivers of the gift.
The IRS had this to say about gifts in Information Letter 2002-0112 on April 15, 2002:
“A gift proceeds from a ‘detached and disinterested generosity,’ and is made ‘out of affection, respect, admiration, charity or like impulses.’"
WePay, a third-party company that distributes the campaign proceeds received by crowdfunding sites, says this on its website:
“As of 2015, the IRS has clarified that WePay is not required to send a Form 1099-K with respect to payments that are made solely as gifts or donations. The purpose of Form 1099-K is to report payments for the provision of goods or services, which may be subject to tax. Gifts and donations typically are not reported as income by recipients, so it is not necessary to send them a Form 1099-K.”
And if you do receive a 1099-K? WePay says:
“It is up to you (and your tax professional) to determine whether these amounts represent taxable income.”
The bottom line is that crowdfunding money isn’t supposed to be taxable if it’s given out of the goodness of the donor’s heart and nothing was received in exchange for the gift.
The situation changes if Mary’s sister gives some good or service in exchange for the public’s donations. Now she—or maybe Mary and Joe—might be expected to report any profits from the donations (minus expenses related to the good or service) as income.
The IRS says:
“If the payment proceeds primarily from ‘any moral or legal duty’ or from ‘the incentive of anticipated benefit’ of an economic nature, it is not a gift.”
And if it’s not a gift, the IRS generally wants its share.
Crowdfunding for Your Business
Starting or operating a business with crowdfunded money isn’t a true gift. As such, it’s taxable income—sometimes. Again, there’s a fine line of distinction here, and it seems to fly in the face of the rewards-based crowdfunding rule, at least on the surface.
Let’s say your awesome new business is struggling to get off the ground. You resort to crowdfunding to raise money to keep it going until you begin to turn a profit. Maybe you offer donors the gadget you’ve invented as a gift in exchange for their money (reward-based crowdfunding). Or maybe you effectively issue stock in your company—they’ll receive a share in your enterprise in exchange for their money. This second incentive is often referred to as “equity crowdfunding.”
Any profit that results from crowdsourced donations isn’t technically “income” when it’s raised from equity crowdfunding. It’s technically an investment if you gave the owner equity or an interest in your business in exchange for the donated money, and that’s not taxable income to your business.
If you paid yourself from that money, you’d have to claim it as income on your personal tax return.
You must report the donation as business income if you do not give the donor anything in return—and sometimes even if you do provide something, provided that it’s not equity in your business.
Anything else is considered a sale (your business gave something and received money in exchange). Or the funds are seen as a means to initiate or continue your business enterprise. And that’s just as taxable as any income your business otherwise provides to you.
According to H&R Block tax attorney Mike Slack:
“If the campaign organizer’s intent is to generate funds for a project that would otherwise be considered a trade or business if viewed outside the context of the fundraising website, any funds raised will be treated as taxable business income.”
The Bottom Line
Crowdfunding sites or their third-party processors of funds will typically pay the individual who set up the account, not the ultimate beneficiary of the money. The crowdfunding organizer might end up receiving a Form 1099-K. It may be wise to consult a tax professional if this happens to you. You might be able to claim an “agency” relationship to eliminate responsibility for any taxes that might be assessed.
Beneficiaries (not organizers) of crowdfunding sources should be prepared to show what was or was not offered or exchanged for the funds received. This is generally provable with campaign records. It may only be an issue though if a 1099-K was submitted, recording the transactions.
Gofundme. "About Gofundme," Accessed Nov. 17, 2019.
Internal Revenue Service. "Number: 2016-0036," Accessed Nov. 17, 2019.
Kickstarter. "Kickstarter and Taxes," Accessed Nov. 17, 2019.
Internal Revenue Service. "Number: INFO 2002-0112," Accessed Nov. 17, 2019.
WePay. "How Will Using WePay Affect My Taxes," Accessed Nov. 17, 2019.
H&R Block. "Last-Minute Tax Surprises: Crowdfunding’s Consequences," Accessed Nov. 17, 2019.
Internal Revenue Service. "Agency: A Critical Factor in Exempt Organizations and Ubit Issues," Accessed Nov. 17, 2019.