Income tax consequences of crowd funding: Check your facts
IRS provides general commentary on crowd funding
TAX ALERT |
Crowd funding is a form of alternative financing that utilizes a large number of people to raise monetary contributions or capital. This non-traditional approach involves individual contributions instead of banks, loans or stock offerings. Crowd funding has rapidly grown from approximately $5 billion in 2013 to over $34 billion in 2015. With this rise in popularity comes the ever-pressing question: What are the income tax consequences?
Not all crowd funding is the same, and as you may suspect, the income tax treatment will vary based upon the specific facts. The path to determining the income tax treatment in a crowd funding arrangement begins with identifying the rights of the funder and funded. In ‘equity crowd funding,’ the funder is an investor making an investment in equity (or debt) of the funded. In these cases, applying general income tax principles may be relatively straightforward as there is significant authority for both parties to address equity and debt investments.
The tax characterization of a funding arrangement, however, is not always clear because there are gray areas of the tax law. In these areas, the funding and funded parties should seek tax advice on tax treatment of their arrangement. See our June 2016 Tax Digest, Tax treatment of a simple agreement for future equity is not a lock.
The IRS generally addressed the income tax consequences of crowd funding in an information letter dated June 30, 2016 (Info 2016-0036). The IRS had been asked whether the funding recipient had constructive receipt of the contributed funds before the funds are used for the planned purchase of a company.
The IRS set out some of the general tax rules that apply to the question but made a point not to get too specific or provide a conclusion. The IRS cited section 61(a) of the Internal Revenue Code, which states that in general, except as otherwise provided by law, gross income means all income from whatever source derived. Therefore, crowd funding revenues are generally includible in income but listed three exceptions (loans, gifts and capital contributions in exchange for equity). Worthy of note was the statement by the IRS that not all voluntary transfers without a ‘quid pro quo’ represent gifts, as this is likely the position some taxpayers have taken in excluding crowd funding receipts.
The information letter noted that income, although not actually reduced to a taxpayer’s possession, is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available (citing regulation section 1.451-2). The IRS also noted that even though such funds may not actually be in taxpayer’s possession, they are constructively received unless subject to substantial limitation.
In conclusion, the IRS stated the income tax consequences to a taxpayer of a crowd funding effort depends on all the facts and circumstances surrounding that effort. Of particular importance in the income tax determination are the rights to both the funded and the funder as a result of the contribution. The information letter provides only a basic roadmap and not enough to get you to your destination.