Do You Have to Pay Income Tax on Crowdfunded Money?
The IRS may want a piece of your donations.
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, GoFundMe has reportedly had over 120 million donations total more than $9 billion since its inception.
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.
Here's what you need to know about when and how taxes apply to crowdfunded donations.
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. The letter doesn't specifically create new provisions for how to handle crowdfunded money, but it does point to some factors that could help people determine whether the donations fall under another section of the Internal Revenue Code (IRC). It comes down to an interpretation of those IRC rules.
Essentially, the main takeaway of the letter is that donations are only taxable income if donors receive something in exchange for their donation, such as a service or product. If not, they’re non-taxable gifts—at least if you’re a private individual and not a business.
If the donations surpass an IRS threshold, then the crowdfunding website must report distributions made to the organizer of the crowdfunding campaign—who then turns the money over to the campaign’s beneficiary—on IRS Form 1099-K. Those thresholds are more than $20,000 and more than 200 transactions during a calendar year.
Receiving a 1099-K doesn’t automatically mean the funds are reportable as income or that the money will be taxed. It still comes down to the nature of the fundraising campaign, and whether the donor receives anything for the money they donated.
When the Money Is a Gift
To better understand when crowdfunded donations are a tax-free gift, it may help to walk through an example.
Let's say 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 family steps in and sets up a crowdfunding account to help the family. They raise $30,000 from 201 people. This exceeds the 1099-K requirements, so the crowdfunding platform sends them a copy of the 1099-K it sent to the IRS.
Assuming that Joe, Mary, and the family didn’t give any of these 201 people anything in exchange for their money, the $30,000 can be considered a gift—it isn't 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 that the IRS has clarified that it may not be necessary to send the IRS a Form 1099-K if the money given qualifies as a gift or donation.
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.”
If it isn't a gift, the IRS generally wants its share.
Crowdfunding for Your Business
Starting or operating a business with crowdfunded money isn’t usually a true gift. As such, it could be taxable income—but it depends on the details of the income.
Let’s say your 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). If you do, you will likely have to report the donation as business income, just like you would with any other sale.
Or maybe you effectively issue stock in your company, and 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—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 use donated funds to pay yourself, you’d have to claim it as income on your personal tax return.
H&R Block advises campaign organizers to consider the intent of their crowdfunding. If the point is to generate funds for a project that would clearly be considered a trade or business outside of the crowdfunding context, then it will likely be considered 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.