Crowdfunding has become a popular way to raise funds for particular causes, but donors and recipients should be aware of the tax requirements involved.
In crowdfunding, typically, a third party raises funds for a charity or cause through their internet platform and then turns the contributions over to the charity or beneficiary, less a fee. It is commonly used to raise funds to help individuals struck by tragedy or a broader charitable cause. For example, GofundMe features a campaign to donate to Ukraine relief efforts and another to help victims of the Sacramento mass shooting.
So, what does all this mean for crowdfunding donors and recipients?
Models of Crowdfunding
There are a variety of internet crowdfunding platforms available, each offering different fundraising services and models. Some platforms take a percentage fee, and some a monthly fee. Some also provide additional donor management and other services. The two models most common for nonprofit organizations are the donor-based model and the rewards-based model.
With the donor-based model, the donor receives nothing in exchange for their donation. The donation is in the nature of a gift, and provided the recipient is a 501(c)(3) charity, a charitable donation deduction should be allowable for the entire amount (unless other limitations apply). We assume, throughout this article, that the funded project is a charitable project and not an unrelated trade or business. Organizations should never use crowdfunding for a business unrelated to its exempt purpose.
In the rewards-based model, the donor receives something in exchange for their donation – sometimes something small like a t-shirt and sometimes something of greater value, like entry into a raffle with a valuable prize. In the rewards-based model, the facts would need to be examined to determine if what the donor receives is de minimis or something of value (typically called a quid pro quo), making part or all of the transaction an exchange rather than a donation. This is important because the donor usually is expecting a full charitable deduction.
To determine if the value the donor receives is de minimis, we look to the general charitable donation rules regarding quid pro quo transactions. There are two tests to determine if the value the donor receives can be disregarded:
- The value the donor receives is 2% or less of the payment, and the value is not more than $117 in 2022 (this is indexed for inflation), or
- The payment is at least $58.50, and the donor received a low-cost article with the donee’s logo that costs less than $11.70 in 2022 (indexed for inflation).
If the value is not disregarded, the charitable deduction is the amount donated that is above the fair market value of the benefit the donor received.
501(c)(3) vs. Individual Contributions
Another important factor in the donors’ deductions is whether the funds are earmarked for a 501(c)(3) exempt charity or specific individuals, as in the case of a campaign to fund a person’s medical expenses, for example. If it is earmarked for individuals, then the donor will not be eligible for a charitable contribution deduction. If the recipient is a qualified Section 501(c)(3) charity, then the donor should be eligible for a charitable contribution deduction.
If the charity does not have a determination from the IRS of exemption under Section 501(c)(3), then it could use a fiscal sponsor.
Fiscal sponsors are organizations exempt under Section 501(c)(3) that collect funds for nonexempt organizations, with the intent that the donations will be allowable as charitable contribution deductions. Fiscal sponsors must take control of the donated funds and maintain discretion over its use. Earmarking the funds for the nonexempt organization will result in no deduction for the donor. However, one can restrict the use of the donated funds for a specific charitable purpose.
Fiscal sponsorship is very complex and beyond the scope of this article. Such arrangements must be carefully set up with help from professional legal and tax advisors.
Donor Acknowledgement Receipts
Donor acknowledgment receipts are also required if the donation is $250 or more, or over $75 if goods or services were provided to the donor in return for the contribution. In some cases, the third-party crowdfunding platform will provide the receipts. The charitable organization should make sure this is done properly regardless of who issues the receipts. If there is a fiscal sponsor, then the fiscal sponsor will typically issue receipts.
Another issue is whether the fee charged by the crowdfunding platform is part of the contribution. Even though the charity receives less than the total contribution, it should record the total contribution as revenue and the fee as a fundraising expense. For example, if the donor donated $100 and the crowdfunder keeps $5 and distributes $95 to the charity, then the charity will record a donation of $100 and a fundraising expense of $5. This also provides more transparency to anyone looking at the organization’s financial statements regarding fundraising costs.
Organizations must be aware that crowdfunding is far reaching and will likely bring in donors from many states.
Most states have charitable solicitation registration requirements, and each state’s requirement is a bit different. Organizations should investigate the requirements of each state and determine what registrations may be required. Fundraising via a crowdfunding platform may be considered “soliciting” in various states which would require registration.
Who needs to file is also a question. The solicitor in a state may be the crowdfunding platform and not the recipient charitable organization. If a fiscal sponsor is used, then the fiscal sponsor may need to register. In addition, the crowdfunding platform may need to register as a professional fundraiser in various states.
Professional firms that specialize in state charitable solicitations filings can help with determining the requirements for the situation. Even if the initial crowdfunding activity is not considered to be soliciting in some states, it could lead to future soliciting which would require registration. For example, if the crowdfunding platform provides the charity with a donor list and the charity solicits those donors in the future, then it may need to register in the donors’ states before it does so.
Reporting to the IRS
Last, third-party fundraisers may have to report distributions of funds raised to the IRS on a Form 1099-K and provide a copy to the recipient of the funds. Form 1099-K is not required if the contributors to the crowdfunding campaign do not receive goods or services for their contributions. Therefore, this would only apply in the rewards-model. The threshold for reporting is payment of greater than $600.
Crowdfunding may be a great opportunity to reach previously untapped donors, as well as provide a quick and convenient way for donors to make contributions. However, organizations contemplating a crowdfunding campaign should consult a trusted tax professional for information and advice before engaging in the campaign and regarding reporting the funds received from it.
If you have questions about your crowdfunding campaign and its tax implications, please send us an email.
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