In an Information Letter, IRS explained the tax treatment of crowdfunding by looking to general principles of income inclusion.
Background. Under Code Sec. 61(a), except as otherwise provided by law, gross income includes all income from whatever source derived. Gross income includes all accessions to wealth, whether realized in the form of cash, property or other economic benefit. However, some benefits that a taxpayer receives are excludable from income, either because they do not meet the definition of gross income or because the law provides a specific exclusion for certain benefits that Congress chooses not to tax.
Reg. § 1.451-2 sets out the constructive receipt doctrine and provides that income, although not actually reduced to a taxpayer’s possession, is constructively received by him in the tax year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the tax year if notice of intention to withdraw had been given. The regs further provide that income isn’t constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions. However, a self-imposed restriction on the availability of income doesn’t legally defer recognition of that income.
Facts. Crowdfunding is the practice of funding a project by gathering online contributions from a large group of backers. It has become a popular way to raise capital for a wide variety of projects from community development to the arts to technology.
Initially, crowdfunding was used by musicians, film makers, and other creative types to raise small sums of money for projects that were unlikely to turn a profit. But the impact of crowdfunding has grown—in some cases, becoming an alternative to venture capital.
The consideration received by contributors to a crowdfunding project in return for their contributions varies considerably. Sometimes contributors receive nothing but the personal satisfaction of helping to launch a cause or create an innovation that they believe in. Often contributors are offered “rewards” of small or nominal value, such as cups with a logo, tee shirts, or tickets to an event. In other cases, contributors may receive the right to have their contributions repaid with interest if the campaign’s financially successful. Or they may receive an equity interest in the endeavor, i.e., a piece of the business.
RIA observation: No cases or IRS rulings directly address the taxability of contributions to a crowdfunding project. Accordingly, whether crowdfunding contributions received are includible in income must be determined by the application of general tax principles.
IRS’s answers. In the Information Letter, IRS concluded that generally, money received without an offsetting liability (such as a repayment obligation), that is neither a capital contribution to an entity in exchange for a capital interest in the entity nor a gift, is includible in income. The facts and circumstances of a particular situation must be considered to determine whether the money received in that situation is income.
What that means is that crowdfunding revenues generally are includible in income if they are not:
1. loans that must be repaid;
2. capital contributed to an entity in exchange for an equity interest in the entity; or
3. gifts made out of detached generosity and without any “quid pro quo.” However, a voluntary transfer without a “quid pro quo” isn’t necessarily a gift for federal income tax purposes.
In addition, crowdfunding revenues must generally be included in income to the extent they are received for services rendered or are gains from the sale of property.
Thus, IRS determined that the income tax consequences to a taxpayer of a crowdfunding effort depend on all the facts and circumstances surrounding that effort.
References: For tax treatment of crowdfunding contributions, see FTC 2d/FIN ¶ J-1009.1; TaxDesk ¶ 101,012.