The Taxation of Crowdfunding: Income Tax Uncertaintanties and a Safe Harbor Test to Claim Gift Tax Exclusion

Abstract

Crowdfunding is the process of asking a large number of separate third parties for relatively small amounts of money to fund an endeavor. Although the concept of asking for financial “contributions” is not new, seeking funds from others via websites on the internet is relatively new. As with any distinctly new financing vehicle, there are many legal issues raised by crowdfunding that have not been explored or answered. One such issue is the income tax consequences associated with crowdfunding. The academy has not yet widely addressed the issues and the Internal Revenue Service (IRS) has yet to provide any formal guidance which has created a lack of clarity that needs to be addressed.This article provides an overview of the most popular types of crowdfunding models and addresses the tax aspects of crowdfunding models that raise funds through a tax-exempt entity and that provide loans or equity investments through crowdfunding. The article also explores the tax uncertainties that arise under current income and gift tax laws and shows that the current tax laws do not provide bright-line answers to whether or not a crowdfunding transaction is taxable income or excluded from tax as a “gift.” However, it is further shown that there are guidelines that do emerge from current tax law that require administrative action by the IRS. It is recommended that to make the taxation of crowdfunding more efficient, equitable and easier to administer, the IRS should issue guidance stating that funds received in a crowdfunding campaign are gross income under Internal Revenue Code section 61. It is further recommended that the IRS should provide a safe harbor test as described in the article which taxpayers can use to determine if funds received in crowdfunding are gifts that are not subject to federal income tax.