Non-taxable Crowdfunding—amending Reporting Requirements to Reflect Social Changes

• Publication year: 2018
• Author: By Michelle B. Graham, Catherine M. Swafford & Kelina M. Smith

Non-Taxable Crowdfunding—Amending Reporting Requirements to Reflect Social Changes1

By Michelle B. Graham, Catherine M. Swafford & Kelina M. Smith²

I. BACKGROUND

A. The Emergence of Crowdfunding

Around 2010, during the recession and government bailouts of corporate banks and automakers, a type of social-civic "bailout" by private citizens emerged known as "crowdfunding." According to the website YouCaring, crowdfunding is defined as "the practice of funding a project or cause by raising money from a large number of people, typically through the Internet. It is a form of peer-to-peer fundraising that harnesses the power of social networks to raise awareness and draw donations from around the world for online campaigns."³ Similarly, Wikipedia defines crowdfunding as "the practice of funding a project or venture by raising monetary contributions from a large number of people."⁴

Given the ease with which one can reach large masses of people using the Internet, online crowdfunding has grown exponentially in recent years, and has emerged as a common way for individuals to seek financial assistance from others. A 2016 Pew Research Center report found that about one-in-five Americans have contributed to an online fundraising campaign.⁵ In addition, three percent of Americans have established an online fund raising project.⁶ The Pew Research Center report also provides that 68 percent of donors have contributed to a campaign seeking to help a person facing a hardship or financial challenge.⁷

According to the research firm Massolution, worldwide crowdfunding grew to $16,200,000,000 in 2014, a 167 percent increase over the $6,100,000,000 raised in 2013.⁸ In North America alone, crowdfunding volumes grew 145 percent to $9,460,000,000 in 2014.⁹ In addition, solely donation and/or gift-based crowdfunding grew 45 percent in 2014.¹⁰ Continuing the trend, the crowdfunding industry grew again in 2015, reaching $34,400,000,000 and more than doubling the previous year's volume.¹¹ This growth is expected to continue, as it has been projected that the global crowdfunding market could increase to between $90,000,000,000 and $96,000,000,000 by 2025.¹²

GoFundMe is the world's largest social fundraising platform and the top personal fundraising website.¹³ Launched in 2010, the company has helped raise $3,000,000,000 through more than 25,000,000 donors.¹⁴ People have raised more money on GoFundMe than anywhere else.¹⁵ The largest online campaigns in 2016 arose from news events and natural disasters.¹⁶ GoFundMe reports that in 2016, $9,000,000 was raised for victims of the Pulse Night Club shooting in Florida, $11,200,000 was raised to support Louisiana flood victims, $3,000,000 was raised to support Hurricane Matthew victims, and $7,800,000 was raised to support Standing Rock protestors.¹⁷ According to the website, "starting a GoFundMe in response to pivotal moments has become part of our social fabric."¹⁸

Besides GoFundMe, other companies provide online platforms for fundraising. They include YouCaring, GiveForward, Fundly, Indiegogo, FundRazr, Kickstarter, iFundWomen, Rally.org, Booster, and others. These and other companies provide platforms for people to establish different types of online fundraising campaigns. Many campaigns seek gifts and donations for social, civic, charitable, or personal causes, while others seek funding for businesses, real estate, arts and entertainment, and the like. This paper focuses solely on the unintended tax consequences impacting persons who establish crowdfunding campaigns to obtain gifts and donations for social, civic, charitable, or personal causes.

B. The Logistics of Crowdfunding

To create a crowdfunding campaign, a person goes to a crowdfunding company's website, such as GoFundMe, and establishes the campaign. He or she creates a home page for the campaign, which explains the reasons why financial assistance is needed in that certain situation. Photographs and videos may be uploaded, and updates can be posted. The campaign is often shared through social media sites, such as Facebook and Instagram, where friends, relatives, colleagues, and other members of the public can view the campaign's page and thereafter contribute donations in any amount. There is generally a goal fundraising amount, and the home page will track the campaign's progress toward such goal.

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Donations that are received through the crowdfunding company's website are held in a separate linked account by a third-party payment processor, such as WePay or PayPal (hereinafter, the "Payment Processor").¹⁹ When the person wants to withdraw the funds, the Payment Processor transfers the money to the person's bank account.²⁰

II. THE PROBLEM IMPACTING CROWDFUNDING CAMPAIGNERS

A. The Unintended Problem

In the case of crowdfunding campaigns of which the purpose is to solicit gifts and donations for social, civic, charitable, or personal causes, an unintended problem has arisen. The Internal Revenue Service ("IRS" or the "Service") is serving audit notices on some taxpayers who receive funds from these crowdfunding campaigns, warning them that they are not accurately reporting all of their income on their tax returns. This is because, under current law, the Payment Processor is required to issue a Form 1099-K for each person who receives funds from his or her crowdfunding campaign. The Form 1099-K categorizes the funds received through the crowdfunding campaign as income; however, the money received from the campaign is comprised of gifts, and not taxable income.

B. Common Hypothetical Scenarios 1. Hypothetical No. 1: Medical and Life Expenses

Tim, a young father of three children and the sole breadwinner of his family, is in a horrific accident. While riding his bike, he is hit by a car and left paralyzed from the neck down. He cannot return to work, support his family, and pay his massive medical bills. Tim establishes a crowdfunding campaign through GoFundMe to seek donations for financial assistance. The campaign receives donations totaling $28,000 ranging from $100 to $1,000 from 250 individuals. Tim uses the money to pay for living expenses and rehabilitate his home to be handicap-accessible. Tim and his wife file their federal income tax return, which includes all earned income for the year, but not the money received from Tim's crowdfunding campaign. Subsequently, Tim and his wife receive a notice from the IRS claiming there is a discrepancy between the income reported on the family's tax return, and that which was reported by WePay in connection with the GoFundMe crowdfunding campaign.

2. Hypothetical No. 2: End of Life Care and Funeral Expenses

Stella and Matt graduate from law school and get married. Both have hundreds of thousands of dollars of student loan debt and they have no money of their own. They start new jobs as young associate attorneys, but soon thereafter, Stella is diagnosed with cancer. Matt must stay home from work to care for Stella, who passes away six months later. Their friend, Rob, establishes a FundRazr campaign to seek donations for Matt and Stella's living expenses, and Stella's caregiving and funeral expenses. The campaign receives donations totaling $40,000 from 300 individuals, with each donation ranging from $100 to $1,500. Rob withdraws the funds from the account and gives the money to Matt. After filing his income tax return, Rob receives a notice from the IRS stating there is a discrepancy between the income he reported on his tax...