Crowdfunding has become a popular way for many entrepreneurs to raise necessary capital from online donations. Projects for which crowdfunding has been used varies greatly in size, industry, and what a contributor may expect in return. While some crowdfunding has been on a very small scale, some projects have eclipsed more than $100 million dollars.
Generally, contributions to the capital of a business are tax free when made by the owner of that business, or if the contributor receives an ownership interest in exchange for the contribution. But what happens when total strangers make contributions to the business and receive nothing in exchange, or something of very little value for their contribution? The IRS recently addressed this issue, applying basic principles of tax law to crowdfunding. In Notice 2016-0036 (https://www.irs.gov/pub/irs-wd/16-0036.pdf ), the IRS explains that crowdfunding revenues are generally included in gross income by the recipient unless the recipient has an obligation to repay (loan), the contribution is in exchange for an ownership interest in the business, or the contribution is a bona fide gift.
Most crowdfunding is made without any obligation of the recipient to repay the contributor the full amount of value and there is rarely an exchange for an equity interest. What about a gift? While a contribution to someone without receiving anything in return may look like a gift, it is much harder to establish a bona fide gift than many contributors may realize. For example, the IRS considers a gift to be any transfer to an individual in which the giver does not receive full consideration of value in return. This makes it difficult, if not impossible, to establish a gift to any business entity or enterprise.
Crowdfunding can be an extremely useful tool in raising capital, but be aware of the tax consequences associated with receiving the contributions.