Ladies and Gentleman: Crowdfunding can be Income

March, 10 2015 by Carolyn Richardson, EA, MBA

Crowdfunding is becoming an increasingly popular way to raise funds for businesses, charities and individuals. Crowdfunding occurs when someone asks others − usually via an internet platform such as Kickstarter, GoFundMe, or Indiegogo − to contribute to their idea or cause. These are frequently used to fund business startups or medical expenses for individuals who would not be able to pay for these things themselves. But did you know that raising money this way may be considered income by the IRS?

In general, income is taxable unless there is a specific exemption for it in the revenue code. Depending on what the crowdfunded money is used for, it may be taxable to the recipient as income. For example, say an artist wants to buy a new glass furnace, but can’t afford the $10,000 cost up front (starving artist and all that). She uses Kickstarter to raise the money and, in exchange, offers a glass piece worth $20 for every $50 contributed. Within two months, she’s raised the money for the furnace. Because the glass artist is considered to be in business, the $10,000 raised would be reported as business income. The cost of the glass pieces sent in exchange would be deductible, such as the cost of the glass used to make the pieces and the postage to mail them to her backers. On the other hand, a video game designer who offers a 1% interest in their game would consider money contributed as a capital investment and, in this case, they have just created a partnership for their game and would need to file a partnership tax return.

In many cases, crowdfunding is done as a “one off” type of thing. This may not create a business or charitable donation, but may actually create hobby income. For example, Zack Brown of Ohio, as a joke, asked people to contribute $1 toward his $10 goal so he could make potato salad. His post went viral and he raised over $55,000. Now, Zack clearly isn’t in the business of making potato salad, so the IRS may consider this to be hobby income, in which case it would be reported as “other income” on the tax return, and the cost of making the potato salad (Zack eventually made salad for over 3,000 residents of his hometown) would be deductible as a miscellaneous itemized deduction, subject to the 2% limitation.

What if Bob and Sue are raising money on GoFundMe to pay medical bills they incurred when Sue was diagnosed with cancer? Generally, money collected for this type of thing would be considered a gift, regardless of whether it’s from family, friends, or total strangers. Gifts are not taxable to the recipient but, likewise, they are not deductible to the donor.

Some crowdfunding sites partner with recognized charitable organizations, and amounts donated to those charitable causes would be deductible. Keep in mind, however, that if you donate $250 or more, you would need a letter from the charity confirming your donation, or the IRS may disallow it in an audit.

As always, when you are asked to give money, it is a wise idea to make sure the plea is legitimate. Crowdfunding websites warn donors that they are not liable for ventures that never actually happen, or when money gets diverted to other uses.  As they say in Vegas: never bet money you can’t afford to lose.