Tax Effects of Crowdfunding Distributions – Charitable and Otherwise
The IRS recently posted guidance on its website about the tax implications of distributions from online crowdfunding. With some regularity I have conversations with students or others who have raised money online for some cause outside the context of any existing 501(c)(3) organization. Sometimes, they want to create 501(c)(3) organizations for future activities, but they have already had online funding platforms distribute funds to them individually, which they have then either transferred to the intended beneficiaries of the fundraising campaign or used for the purposes described in the fundraising campaign. They want to know what the tax implications are. I usually tell them to go back in time and not to put themselves in the middle of a charitable contribution or gift without some sound legal advice, but that’s because of state charitable solicitation law reasons as much as federal tax reasons.
As for the tax implications, the IRS helpfully explains that crowdfunding payments “may be includible in the gross income of the person receiving them depending on the facts and circumstances.” In general, if someone gets money, it is taxable income unless some exception applies. In this case, the IRS mentions two exceptions: gifts and charitable donations. But also, another important principle is at play because, as the IRS notes, money raised by crowdfunding may be “on behalf of other people or businesses.” That principle is the fact that a person who receives money as an agent of someone else, and dutifully delivers that money to the principal, does not have taxable income.
With regard to charitable contributions, the question of whether a distribution is taxable should be relatively simple: either the recipient of the distribution is a charity (no income) or the recipient dutifully delivered the distribution to a charity (no income). There could be a hiccup if the recipient received the income in one year and delivered it to a charity in the next, but that shouldn’t be an insurmountable hiccup; it just might take some explaining.
The more difficult analysis has to do with whether the distribution is a gift. Here, the question is not who got the funds, but whether they were given out of detached and disinterested generosity, and (as anyone who has ever taken a law school tax class knows), that can be hard to assess. If the recipient of the crowdfunding distribution spent the money on behalf of a charitable purpose, instead of distributing money to an intended beneficiary, the question of whether it could be a “gift” is even harder to assess.
The difficulty in assessing the tax treatment of crowdfunding distributions is at the heart of the real purpose of the IRS’s website guidance, which is to explain the reporting regime, not the tax treatment. Congress required crowdfunding websites starting in 2024 to report all taxable distributions over $600 to the IRS on a Form 1099-K, although that rule has not yet been implemented by the IRS. The problem with the rule is that crowdfunding websites are not well situated to assess all the relevant facts and circumstances, and so good faith efforts to comply with the reporting requirements will likely produce substantial reporting of non-taxable distributions on Forms 1099-K – distributions that are really gifts or charitable contributions. So, what does the recipient of such erroneous 1099-Ks do? The IRS website guidance explains how to report these distributions on one’s tax return, and urges the taxpayer to “keep complete and accurate records of all facts and circumstances surrounding the fundraising and disposition of funds for at least three years.” Seems like good advice.
–Benjamin Leff