I’m seeing so many small businesses and individuals jump on the bandwagons that an internet economy has provided us: crowdfunding, airbnb/vrbo, and ride-sharing are among the most common. And in each of these situations, the ease of doing business belies the complexity of the accounting and taxation principles and rules underlying the true nature of the transactions.
These two articles do an amazing job of explaining the factors to consider when evaluating how (or in less frequent instances, if) crowdfunding income should be taxed. I’ve taken excerpts and copied/pasted a summary here, but I strongly encourage both accountants and small businesses/individuals considering crowdfunding to read the entirety of each article.
The first, “Crowdfunding and income taxes,” deals with income tax ramifications, and the second, “Crowdfunding Contributions and State Sales and Use Taxes,” deals with sales and use tax considerations (note: as of the publication date, the link to this second article is incorrect where referred to in the first article; however, the link here is accurate).
Thousands of businesses and individuals have succeeded in attracting funding through crowdfunding sites, but often with little thought to the ramifications for income taxes. Congress and the IRS have not addressed crowdfunding income specifically, leaving scant guidance for CPA tax advisers whose clients may have this source of income. Still, applying common tax principles and common sense may help tax preparers and advisers in talking through the issues with their clients who have taxable crowdfunding income and deciding how to report and pay taxes on it.
Crowdfunding in the United States falls into three distinct types:
1) for creative enterprises, which can be characterized as reward-based crowdfunding;
2) as a means of personal fundraising, or donation-based crowdfunding; and,
3) equity-based crowdfunding, which raises capital for companies.
While pledges received from donation-based crowdfunding are likely to be considered nontaxable gifts, reward-based crowdfunding is likely to carry income tax ramifications for the project creator. As for which expenses should be deductible against the income, that depends on several factors, including:
– Whether the crowdfunding activity is deemed a trade or business or a hobby;
– Whether the activity is deemed a startup business;
– The method of accounting used by the creator; and,
– The value of rewards given to backers.
[Note: in my practice, I most often see crowdfunding used for startups and expansions, and therefore follow the rules for capitalization of costs — and in certain situations, deferral of income until the year the trade or business becomes active. If you are working in this context, please read that section of the article carefully and do your due diligence in researching the particulars, as it is a ‘facts and circumstances’ situation.]
It is important to recognize that amounts received as a reward-based crowdfunding campaign which promises a reward that has some value is unlikely to be considered a gift, and much more likely that at least some portion of it should be considered a purchase. This should lead to a discussion of how sales and use taxes should be handled on purchases of products. Factors to consider, addressed in the second excellent article, include:
– Tax Base
To reiterate what I said at the beginning of this post: I’m seeing so many small businesses and individuals jump on the bandwagons that an internet economy has provided us: crowdfunding, airbnb/vrbo, and ride-sharing are among the most common. And in each of these situations, the ease of doing business belies the complexity of the accounting and taxation principles and rules underlying the true nature of the transactions.