Every holiday season, I, like many other Americans, watch Frank Capra's classic, It's a Wonderful Life. While the movie has a number of iconic scenes, the most heartwarming scene occurs at the end, as the citizens of Bedford Falls gather in George Bailey's home and give him the money he needs to get out of trouble with Mr. Potter. Although I find the movie as inspiring as others do, because I'm a tax lawyer, I'm left with one troublesome question: should George Bailey have reported that money on his tax return?
Today, the citizens of Bedford Falls might use crowdfunding to raise the money for George. Crowdfunding has become especially popular for raising money for social causes, charitable ventures and start-up businesses. Consequently, the law is beginning to address its tax consequences. The IRS recently issued an information letter addressing its treatment of crowdfunding campaigns for income tax purposes. The IRS letter states that whether the beneficiary of a crowdfunding campaign must include the money received as income depends on all of the facts and circumstances—not a very helpful test. But, depending on the circumstances surrounding the campaign, the money could be includible as income or excluded as a gift or a capital contribution.
Generally, a taxpayer does not pay income tax on money received as a gift. A gift is defined as something of value given from a "detached and disinterested generosity out of affection, respect, admiration, charity, or like impulses." Therefore, the citizens of Bedford Falls' crowdfunding campaign to save George from the bank examiners would likely be treated as a nontaxable gift. The same would be true for more traditional charitable crowdfundings such as fundraising for a child's scholarship fund or to help someone pay for their puppy's surgery.
However, the tax treatment of crowdfunding campaigns for start-up businesses is more uncertain. A typical start up business could involve an artist who wants to set up a new studio. The artist sets up a crowdfunding campaign asking for contributions to set up the studio so he can create works of art to beautify the city. The artist does not promise to give any of the contributors anything in return. In this case, the contributions should be considered gifts as the only reason a person to contribute is out of generosity and a desire to help the artist beautify the city. However, if the artist provides contributors with a work of art (worth more than nominal value) in exchange for the contribution, the IRS likely would not treat that contribution as a gift.
The status of crowdfunding campaigns for pure for-profit ventures may be more unclear. For example, someone might seek money to develop and produce a video game, new computer hardware, or a sharper razor. Contributors receive nothing in return other than the personal satisfaction of helping an innovator. Although these examples involve pure economic activity with little or no apparent social benefit, it would still seem that the contribution is made from "disinterested generosity," "admiration," or "like impulses." Whether the IRS would agree is another question; it might well take the position that such donations are income to the recipient.
Not only are there tax issues for the crowdfunding recipients, the contributors may have tax issues. For example, a donor to a crowdfunding project that is purely charitable, such as feeding the homeless or purifying drinking water, might assume that the contribution would be deductible. In fact, gifts and charitable contributions generally are not deductible unless made to organizations that have or have applied for an exemption under Section 501(c)(3). Charitable gifts made directly to poor, sick, or homeless individuals are not deductible. If you desire a deduction, it should be made to an organization that has a determination letter acknowledging its Section 501(c)(3) exemption or a church.
In some circumstances, the contributor could possibly take a business-expense deduction for a crowdfunding contribution. For example if, in exchange for a crowdfunding contribution, the recipient agrees to display the contributor's name on its products, the contributor's business may receive economic benefit. In these circumstances, the contributor may be able to deduct the contribution as an advertising business expense.
As crowdfunding grows in popularity and usage, taxpayers utilizing this fundraising method should be aware of potential tax consequences. If they don't, they may hear from the IRS, making their lives a little less wonderful.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
