Crowdfunding was created to kick-start the funding of a project. Previously if someone was interested in acquiring funds, they had only a few options to do so. Those options included: raising money from family and friends, taking out a loan, or trying to gather all of the money themselves. With the option of crowdfunding, a new way of raising money was introduced. Crowdfunding created a way to raise money from a population that businesses, charities, and individuals may not have had access to before.
There are different types of crowdfunding: reward-based, equity-based, debt-based, and donation-based, all with their own variations. Donation-based crowdfunding is when individuals donate to a charity or cause through a website like GoFundMe or Facebook. Reward-based crowdfunding is when an individual donates in exchange for some type of reward. Equity-based crowdfunding is a way to raise capital online from investors specifically to fund a private business. In return for their contributions, investors will receive equity in the business. With businesses offering securities instead of goods and services, the funds received from equity-based crowdfunding are non-taxable. Debt-based crowdfunding is a loan of capital to a business for repayment along with interest over time.
Now, the benefit to crowdfunding is anyone can invest. Suppose you want to invest. Because of the risks that come with crowdfunding, there are limitations on how much you can invest over a 12-month period. The limit is based upon your annual income and net worth. For example, if both your net worth and annual income are equal to or more than $107,000, then during that 12-month period you can invest up to 10% of your annual income or net worth, whichever is greater. However, if either your income or net worth is less than $107,000, then the investment is limited to the greater of either $2,200 or 5% of the greater of your annual income or net worth. On the other hand, if you are an accredited investor there are no limits on investing.
There are two different campaigns of crowdfunding, “all-or-nothing” and “flexible- funding”. The all-or-nothing method is when the recipient receives the donations only if the fundraising goal is met in the set period of time. In other words, if the goal is to raise $15,000 in 30 days and on day 30 only $14,000 has been raised, no funds would be received and all of the donors would either not be charged or get their money back to their method of payment. Under a flexible- funding campaign the recipient would receive all of the donations even if the goal is not met in the set period of time. One important thing to remember as well is that crowdfunding sites like GoFundMe will take a percentage from those donations. That percentage typically ranges from 5% to 12%, dependent upon a number of factors that vary across the different sites.
“The American Rescue Plan Act clarifies that the crowdfunding website or its payment processor is not required to file Form 1099-K with the IRS or furnish it to the person to whom the distributions are made if the contributors to the crowdfunding campaign do not receive goods or services for their contributions.” (Money Received through “Crowdfunding” May Be Taxable; Taxpayers Should Understand Their Obligations and the Benefits of Good Recordkeeping | Internal Revenue Service, 2022).
Prior to 2022, a 1099-K was only required if all of the payments that were received exceeded $20,000, stemming from more than 200 transactions. Not too bad, right? However, after the 31st of December the threshold was lowered to $600. For state taxes, depending on the state, sales tax may be due. For example, New Jersey offers an Intrastate Crowdfunding Exemption. Per NJ Consumer Affairs the conditions needing to be met to qualify for this exemption are:
“ For an offering to qualify for the transaction exemption set forth in N.J.S.A. 49:3-50(b)(14), the following conditions must be met:
- The issuer is a business entity organized under the laws of this State and authorized to do business in this State;
- The transaction meets the requirements for the Federal exemption for intrastate offerings in section 3(a)(11) of the Federal Securities Act of 1933 (15 U.S.C. § 77c(a)(11)), and Rule 147 adopted under the Securities Act of 1933 (17 C.F.R. 230.147);
- The sum of all cash and other consideration to be received for all sales of the security in reliance on the exemption under N.J.S.A. 49:3-50(b)(14), excluding sales to any accredited investor or institutional investor, does not exceed $1,000,000.00;
- The offering is not a blind pool;
- The offering by the issuer is made exclusively through a single Internet site operator which meets the requirements of N.J.A.C. 13:47A-12A.4;
- The issuer does not accept an investment of more than $5,000.00 from any single investor unless the investor is an accredited investor, as defined by N.J.S.A. 49:3-49(p) or institutional buyer, as defined by N.J.S.A. 49:3-49(t);
- The investor in the security is a resident of this State; (New Jersey Intrastate Offering (Crowdfunding) FAQs, 2016)
Depending upon the type of crowdfunding, the income received may or may not be taxable. Reward-based crowdfunding will always be taxable since a good or service is received in return for the investor’s contributions. Whereas equity- and donation-based would not be considered taxable because technically no good or service is received in return. Businesses may be able to deduct expenses from the crowdfunding income as long as the contribution is equity- or reward-based. One bonus to this is if a business raises just enough money to cover the cost of a specific project, net income would be close to zero; it is even possible to have a deductible loss if the expenses exceed the income. However, timing is important in this scenario; the timing of the expenses has to match up with the period the income is raised. Issues may arise if the income from crowdfunding is received in one year and the expenses are incurred the subsequent year, because taxes are due in the year income is received. With the whole point of crowdfunding being to raise money to fund businesses or make charitable donations and gifts, the majority of the time, as long as the crowdfunding was a gift or charitable donation, taxes can be avoided altogether. Although there are some instances where a single donation might exceed the gift tax exclusion (currently $16,000) the donor would be responsible for the tax in that case. Overall, as long as crowdfunding is used in the way it is meant to be instead of for gain, taxation can be avoided.
If you are considering crowdfunding and would like assistance, please contact us.
Article Submitted by Lilli Schafer
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