By Joe Burwick, CPA
Crowdfunding is not a new concept, as grassroots fundraising dates back to 1997. But with new platforms, like that of IndieGoGo and Kickstarter, crowdfunding has gained traction in raising revenues for donations, charities, and businesses.
What types are there?
Crowdfunding relies on the concept of asking large groups of organizations and individuals, to contribute to a project. There are three primary types of crowdfunding:
Donation or Reward. When people give money towards a project and receive a gift or promise of one of the finished products in return.
Debt. Receiving funding from people with the expectation they will be paid back with interest in the future.
Equity. This involves getting a large number of people to buy into an idea in return for equity in the project or business.
Depending on the structure of the transaction (Equity, Debt, or Donation/Reward) there are differing tax implications and reporting requirements. For instance, donations/rewards where the investor receives something in return is a taxable event and must be included in gross receipts. However, if deductible business expenses exceed your crowdfunding revenue and other operating revenue, then you won’t owe income tax (but may owe franchise or minimum taxes).
Depending on how the payments are received, the crowdfunding recipient may get Form 1099-K. If payments are made by credit card or if payment in settlement of third party network transactions (i.e. PayPal) where gross payments exceed $20,000 and there are more than 200 transactions, you may receive one of these forms. The IRS will look to match (and analyze) the income on your return to Form 1099-K you receive.
In response to the growing popularity of Crowdfunding, the JOBS act set the Crowdfunding exemption for equity interest offered to the public at a ceiling of $1,000,000 for the aggregate amount sold to all investors in a twelve month period. Prior to this act you had to either register with the SEC or meet another exception before offering securities to the public.
The act further limits the amount sold to any individual investor based upon their annual income or net worth as follows:
If annual income or net worth is less than $100,000; the aggregate amount sold to such investor cannot exceed $2,000 or 5 percent of net worth / annual income.
If annual income or net worth is greater than $100,000 the aggregate amount sold to such investor cannot exceed ten percent of the annual income or net worth of the investor (not to exceed a maximum aggregate amount of $100,000).
You should consult a tax advisor to determine if the amounts received can be excluded from income (i.e. under Internal Revenue Code Section 118 for a Corporation).
What are the Financial Reporting Requirements?
Not only are there potential tax implications to these equity investments, but you must meet various financial reporting requirements as well. Here is what you have to know to meet the financial condition requirements clause of the JOBS act:
Different offering amounts have different SEC financial reporting standards. Congress has set forth the standards as follows:
If the target offering is $100,000 or less, the most recently completed income tax return and financial statements certified by the principal executive officer of the issuer must be provided.
If the target offering is more than $100,000, but not more than $500,000, financial statements reviewed by a public accountant independent of the issuer must be provided.
If the target offering is $500,000 or more, audited financial statements reviewed by a public accountant independent of the issuer must be provided.
As new provisions of the JOBS Act are rolled out, it seems to have raised more questions than answers for entrepreneurs and online start ups. While the bill was designed to help companies tap investors for the early cash they need to get established and hire workers, easing federal requirements for completing private share offerings; a young company would then be bound by SEC rules protecting the rights of their new stockholders, as well as certain state laws.
Don’t expect state security regulators to ease up anytime soon. As crowdfunding gains traction (and the dollars associated with it grow), so too will the scrutinizing of start-ups that issue shares through crowdfunding. Due to the complexities of parts of the JOBS Act and SEC rules toward crowdfunding, entrepreneurs should talk to a tax consultant; to be aware of all the state and federal regulations and the impact it may have at tax time.
Freed Maxick CPAs
Freed Maxick tax auditors will keep you up to date on the most pressing tax issues. If you would like to know how crowdfunding may affect your business at tax time Contact us and connect with our experts.