It's a Question That's Been Coming Up a Lot This Year
SMITH BRAIN TRUST – The tax season has just begun, and Maryland Smith’s Samuel Handwerger says already he’s noticing a trend. This year, taxpayers have a whole lot of questions about crowdfunding.
The questions aren’t entirely surprising, Handwerger says, given the surge in crowdfunding that happened during the pandemic. The answers, he adds, are a mix of good news and bad news. The crowd-finding industry saw record growth in 2020.
Here are some of the questions he’s hearing:
- “I gave to a crowdfunding campaign for an individual, so can we put that down as a tax-deductible donation?”
- “I received money from a crowdfunding campaign that I sponsored. Is that taxable to me?”
- “I gave money to a charity, with my donation earmarked to help a specific person I knew who was severely affected by COVID. Can we put that down as a tax-deductible donation?”
- “I received money from a crowdfunding source into my business account. Is this taxable?”
These transactions are not ambiguous, Handwerger notes. “Since they involve exchange of dollars you know the tax code will have something to say about each one. And indeed it does.”
For the taxpayers who saw a crowdfunding appeal that tugged at their heartstrings, are those charitable donations tax-deductible?
No, says Handwerger. “While giving to a needy person’s crowdfunding campaign qualifies as a good deed in the heavenly code, the tax code does not recognize this as a deductible charitable donation.”
In defining what “charity” means in the tax code, the Supreme Court has said, “Charity begins where the certainty in beneficiaries ends, for it is the uncertainty of the objects and not the mode of relieving them which forms the essential element of charity.”
Clear enough, right?
“OK, I’m not sure what that means either, but it seems like a fun one to memorize and recite at the next Zoom party,” says Handwerger. Basically, he goes on, it means that it is not charity unless it is meant for a charitable class of individuals. Making a donation for the benefit of one at the exclusion of others is certainly a “gift,” but it is not charitable.
For people who benefitted from a crowdfunding campaign aimed at helping them weather a family financial crisis, do they owe tax on those gifts?
No, says Handwerger. “The receipt of those monies are gifts, albeit not charitable gifts, from the various donors. Gifts in the tax code are not subject to income tax to the recipient.”
However, that’s true only if the crowdfunding sponsor offered nothing in return for those so-called gifts. “Once you start getting into a possible “quid pro quo” arrangement, now the tax code will look at this as a business transaction and it becomes a taxable event,” Handwerger adds.
So, if the crowdfunding campaign offered Tshirts or a batch of chocolate chip cookies for donors who make contributions of $10 or more, that’s no longer a gift – it’s a sale. “And that is taxable income.”
What about the taxpayers who gave money to a charitable organization, with their donation earmarked to help a specific person whom they know to be severely affected by COVID-19? Are their donations tax-deductible?
Sorry, says Handwerger. “Remember that Supreme Court opinion I suggested we memorize? A gift with the intention to benefit only certain people privately without the possibility of assisting a ‘class’ of individuals in need of charity is only a gift, it is not a ‘charitable’ gift.”
Donors wanting a charitable organization to “earmark” a donation for the specific benefit of a named individual cannot obtain a deduction for that gift. In such a case, the donation is not considered a contribution to charity. It’s merely using the charity as a conduit for a gift to a specific individual.
On the other hand, general use restrictions, such as a stipulation that funds be used for school scholarships or a building fund, are acceptable and aren’t considered improper earmarks.
And what about a business that receives money from a crowdfunding site? Is that money taxable or is it a gift?
“Oh boy”, says Handwerger. “A business receiving money from a crowdsourcing site certainly cannot claim that as a ‘gift.’ Gifts to a business is somewhat of an oxymoron. You can be gratuitous out of the goodness of your heart to a human, but not to a business.”
He says the tax result here will depend on how the funds were raised.
“Suppose the business was still in the development phase and the venture capitalists took a hike when the pandemic broke loose,” Handwerger says. “So the business owner sets up a crowdsourcing fund asking for help, with a promise that donors will receive a working version of the gadget under invention when it’s done. This is ‘reward-based crowdfunding’ and it’s taxable income to the business.”
On the other hand, Handwerger says, if the donor receives a piece of the business as an owner/investor, then the money received is not taxable. It is equity crowdfunding – and it is also not deductible by the giver. “It’s an investment made with the expectation of a possible return on the money.”
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