The Tax Implications of Donation-Based Crowdfunding

Are you considering setting up a crowdfunding campaign for yourself, or someone you know, to help pay for medical bills, tuition, or raise money for a cause? While there are different types of crowdfunding, we address donation-based crowdfunding in this post since it is the kind we see most often.

Money received from donation-based crowdfunding should be considered gifts, and therefore non-taxable. However, payment processors used by crowdfunding sites, such as Paypal, may issue a Form 1099-K to the recipient regardless of whether the crowdfunding proceeds are taxable or not. The 1099-K notifies the IRS that the taxpayer received income from a crowdfunding site, and if the taxpayer did not claim the income on their tax return (thinking it was a gift), the IRS may issue a deficiency letter.

The burden of proof lies with the taxpayer. Even if the funds should be non-taxable, typically these letters go out after time has passed and the taxpayer doesn't have sufficient documentation to verify the nature of the crowdfunding proceeds. To prevent confusion, we offer the following guidelines in approaching this type of transaction. The goal is to be as proactive and transparent as possible in the event you are challenged on the tax implications of your crowdfunding proceeds.

1) When you create a crowdfunding website, include the following details:

Campaign Purpose - Define what the campaign proceeds will be used for. Beneficiary - Identify who will be receiving the funds raised during the campaign. Creator - If the campaign is created by someone other than the Beneficiary, clearly identify that person as the Creator and note that he/she is acting on behalf of the Beneficiary listed. Donations - State that donations to the Campaign Purpose are solicited and donors will receive nothing in return for their donation.

2) Save an electronic copy of the crowdfunding site with all the details outlined in #1. Your campaign website may be removed by the time the IRS issues a deficiency notice. Maintaining a copy allows you show that the transaction was clearly labeled.

3) Keep documentation of the money trail. For example, if you create a website for a friend, you will receive the funds from the crowdfunding site, and the potential 1099-K, even though you created the site for someone else and didn't keep the money. To protect yourself, you need to be able to verify that you transferred this exact amount to your friend.

4) Maintain records to prove that the donations received were spent as promised according to the Campaign Purpose. Following the above example, the ultimate recipient of the funds (my friend) must have documentation to show that he/she spent the proceeds according to the Campaign Purpose.

Payment processors are only required to send out 1099-K's if the campaign had more than 200 contributors and raised more than $20,000.Regardless of what success you expect from your campaign, it is good policy to follow these steps. All income is taxable unless you can prove it qualifies as an exception. Even if you don't receive a 1099-K, you may still get questioned about the transaction if you get audited.

This information is not a substitute for tax advice. We recommend speaking with your tax advisor if you have any questions relating to your particular situation. The rules are complicated and these steps are not a guarantee that your argument will work with the IRS.

Source: March 2018 issue of Journal of Accountancy.

Linda Rogers, CFP®, EA, MSBA is the owner and founder of Planning Within Reach, LLC (PWR). Originally from New Jersey, Linda services clients throughout San Diego county and nationwide. She leads the design of PWR's investment portfolios which utilize broad, low-cost investments that integrate environmentally, socially, and governance (ESG) factors.

Planning Within Reach, LLC (PWR) is a fee-only and fiduciary wealth management firm offering one-time comprehensive financial planning, ongoing impact-focused investment management and tax preparation services in San Diego and nationwide. PWR is a woman-owned firm that specializes in busy professionals and impact investors. Planning Within Reach, LLC and their advisors do not receive commissions and do not hold any insurance licenses or brokerage relationships.