Last-minute tax surprises: crowdfunding’s consequences
Crowdfunding has proliferated in the last several years as both a way to raise money for business or creative projects as well as to donate to people in need. Funders and campaign organizers might not think about it again, especially if it is a one-time project or a small part of a much larger event.
But then tax season rolls around and a 1099-K shows up in the mail reporting the financial transactions. The IRS gets the same information and likely will audit the taxpayer’s return if it doesn’t include that income. Mike Slack, tax attorney at The Tax Institute at H&R Block, said the IRS has been sending more notices to taxpayers who received a 1099-K but did not report the income.
However, the way a taxpayer should report the income will vary by situation and could result in very different outcomes.
“How taxpayers should report the amounts on this form on their tax returns varies depending on the nature of the payments,” said Slack, pointing out that “the tax implications can be surprising for taxpayers who don’t look into the potential results of their campaigns and/or donations.”
Crowdfunding creative ventures
Although some taxpayers may use crowdfunding platforms to keep up with their hobby, Slack says it is likely the IRS will consider the activity to rise to the level of a business.
“If the campaign organizer’s intent is to generate funds for a project that would otherwise be considered a trade or business if viewed outside the context of the fundraising website, any funds raised will be treated as taxable business income,” said Slack. “The clearest example is when backers will receive products or services in exchange for their contributions.”
The disadvantage of being considered a business is the organizer could owe self-employment tax in addition to income tax on the funds. However, the advantage is they could deduct their business expenses even in excess of their income. Hobbyists can only deduct expenses to the extent of their income.
Crowdfunding for charitable or personal causes, like for medical costs or wedding gifts, can touch on the tax situations for both the giver and recipient. People who make charitable contributions should be tracking those donations so they can see if it is to their advantage to itemize their deductions. If they are tracking these expenses, they may think their donation to a friend’s medical fund will be another itemized deduction. However, these donations are not deductible.
Only contributions to qualified charitable organizations, which can be found using the IRS charity search tool, are tax deductible, “no matter how charitable the intentions of crowdfunding campaigns may be,” said Slack.
So while the funder won’t be able to deduct their gift, in some extreme cases they may have to pay a gift tax. This is only true for gifts greater than $14,000 to a single individual so it is not likely to affect many crowdfunding campaigns.
For the recipients, the funds will typically not be taxable if the giver does not receive something for their contribution. However, they may still receive a 1099-K if the campaign had more than 200 contributors and raised more than $20,000. Because the IRS will have this information, it will likely send a notice asking about “underreported income.” That does not mean the taxpayer needs to pay taxes on the amount, but the taxpayer should have documents and records to show the IRS why the funds are not taxable. Taxpayers should also speak to a qualified tax professional if they receive an IRS notice or come under an audit.
For more information, read Slack’s article Crowdfunding: One platform with many tax results.
By Annelise Wiens
As the newsroom editor, Annelise Wiens is interested in more than just tax and industry news, but the stories of H&R Block's 80,000 associates, their communities and H&R Block's world headquarters in Kansas City, Missouri. Wiens joined H&R Block in 2014 from a public relations agency, where she worked with clients in the financial services industry. Before that, she worked as a communicator for a senior member of the United States House of Representatives. She graduated from Biola University in La Mirada, CA with a bachelor's degree in history.