Legal and Tax Implications of Crowdfunding

There are various tax and legal problems to be aware of when launching a crowdfunding campaign. Further information may be found here.

What you’ll discover:

Is the money received via crowdfunding taxed?
Are gifts made via crowdfunding tax deductible?
How do developers of crowdfunding determine how much money to disclose on their tax returns?
What legal considerations should I bear in mind while crowdfunding?

Crowdfunding is a method of raising cash that involves collecting small sums of money from a large number of individuals. They often utilize the funds raised to create a product or service or to assist a person or company in need. Crowdfunding is classified into two types: reward-based crowdfunding and donation-based crowdfunding. Anyone may contribute money to a project, product, or service in return for something of value via reward-based crowdfunding. Donation-based crowdfunding generates funds to assist a person or organization in need without exchanging products or services for donations.

Is the money received via crowdfunding taxed?

Money received via donation-based crowdsourcing to assist those in need is often not taxed. If money is collected by a 501(c)(3) nonprofit, the IRS recognizes contributions to the crowdfunding campaign as gifts to the 501(c)(3) organization. If the funds are being raised for a specific individual, the IRS will usually classify the contributions as gifts to that person. In any situation, the individual or business that receives the donation-based crowdfunding money, known as the receiver, normally does not pay taxes on it.

Contributions to reward-based crowdfunding campaigns are virtually always taxable income for the person receiving them. A contributor may contribute to a reward-based crowdfunding campaign without expecting anything in return. The receiver may attempt to claim that the contribution is a gift since the giver did not expect anything in return. If the receiver is a for-profit company, which is the situation with most reward-based crowdfunding, the IRS is unlikely to accept this reasoning.

When a company utilizes reward-based crowdfunding to collect cash, it may still deduct business expenditures from its tax bill, just like any other company. Hence, even if the crowdfunding money is taxable income, company costs may reduce the amount of income tax owed on the crowdfunding money.

Are gifts made via crowdfunding tax deductible?

When something is tax deductible, you do not have to include its value in your income, which might reduce the amount of tax you must pay. Crowdfunding gifts are typically tax deductible only if the receiver is a qualified charitable organization, such as a 501(c)(3) charity. Contributions to individuals are often not tax deductible. For example, if you give to a crowdfunding effort to assist a friend who needs money to meet medical expenditures, it is unlikely that your contribution would be tax-deductible. The IRS considers these sorts of contributions to be gifts that are not tax deductible.

If you give to a crowdfunding campaign that benefits a 501(c)(3) organization, your contribution is typically tax deductible. If you get anything of value in exchange for your gift, the portion of your donation that matches the value of what you received is usually not tax deductible.

For example, if you give $100 to a 501(c)(3) nonprofit’s crowdfunding campaign and get a product worth $60, the tax-deductible portion of your gift is $40.

Note that even tax-deductible gifts may not provide a tax advantage in your unique situation. To benefit from charitable gifts, you must normally report all of the tax-deductible items on your tax return.

If you have any doubts about how giving to a 501(c)(3) nonprofit’s crowdfunding campaign may effect your taxes, you should consult with a lawyer or tax specialist.

How do developers of crowdfunding determine how much money to disclose on their tax returns?

For donation-based crowdfunding campaigns for medical or personal assistance, the crowdfunding creator may not need to disclose it as income on their tax return.

The money raised via reward-based crowdfunding campaigns is often regarded the same as any other company revenue. The beneficiary often declares the crowdsourcing funds as company income and cites any business costs in order to reduce the amount of income taxed.

Taxable crowdfunding revenue is typically taxed in the year it is received. If your company costs from a crowdfunding campaign occur the year after you get the funds, you may have to pay higher tax. If you are considering crowdfunding near the conclusion of a tax year, you should exercise caution. Having income and spending in various years may result in having to pay extra tax.

What legal considerations should I bear in mind while crowdfunding?

By crowdfunding, you risk being legally liable for any problems that arise as a consequence of your campaign.

It may be wise to join with an existing 501(c)(3) or build your own non-profit for donation-based crowdfunding to assist groups. Crowdfunding for a person’s medical or funeral needs may be challenging, so get legal counsel when putting it up to ensure that everything runs smoothly during stressful times.

When you use reward-based crowdfunding to generate cash, you are essentially entering into a contract with your contributors. The contract is often ambiguous, which may lead to legal issues if you disagree with your donors. To prevent difficulties, be explicit when discussing the incentives your contributors will get for their contributions. It is also a good idea to ensure that you can maintain your half of the bargain by delivering the prize by the deadline.

Running reward-based crowdfunding campaigns via a company, such as an LLC, corporation, or partnership, is also an excellent idea. You should consult with a lawyer to determine the optimal company structure for your enterprise.

The new product or service for which you are raising funds is also known as your intellectual property (IP). Before making it accessible to the public, check to see whether it is covered by any necessary patents, copyrights, or trademarks. The last thing you want is for your crowdfunding campaign to be launched just to have your ideas stolen by another company that can get to market quicker. It is also a good idea to ensure that your company concept does not utilize an idea or technology that has been patented or legally protected by someone else.