Can using crowdfunding websites bring an unexpected tax bill?
It is not uncommon to see good Samaritans establish crowdfunding accounts for the benefit of individuals experiencing a special financial need, quite often extraordinary medical expenses.
Crowdfunding is generally done using an online platform such as Kickstarter, GoFundMe, and others. They allow the fundraiser to explain the nature of the need, including the amount of money they hope to raise, and the time frame (deadline) for the money-raising campaign. Typically, benefactors who are interested in participating use their credit card to make a pledge, and if the campaign meets its financial goals within the deadline, the crowdfunding site will process the card-based pledges and fund the campaign.
However, overshadowing crowdfunding are the associated tax issues. Take, for instance, a well-meaning young lady named Kate, who received a 1099-K reporting $36,000 of income under her name, which was the amount of the funds she helped raise for a cancer victim.
In yet another case, a woman by the name of Casey received a $19,000 tax bill from the IRS for the $50,000 she raised through GoFundMe to help pay for her medical expenses as the result of a serious car accident and the cancer the doctors discovered while treating her accident injuries.
How does the IRS know about crowdfunding contributions?
A few years ago, they initiated a program where third party settlement companies such as credit card companies, Pay Pal, and others handling the transfer of funds by credit or debit were required to track annual payments to merchants and report them on a form 1099-K. The purpose being to catch merchants who underreport income! Unfortunately, crowdfunding transactions are also handled by these same third party settlement companies and the law requires them to issue form 1099-K for all transactions. The result is that the individual who sets up the account will receive a 1099-K, which causes the IRS's computer to register them as a merchant, followed by an office or correspondence audit.
The problem is that the IRS has not, to date, provided any guidance whatsoever with regard to crowdfunding. In other words, nobody has any idea what the IRS's position is. The fact that those receiving 1099-K are automatically considered merchants who have not reported business income doesn't mean the income is taxable to the recipient--it just looks taxable. This can create problems for the individual who sets up a crowdfunding account using his or her tax ID number!
Code Sec. 61 (a)(1) defines gross income as "all income from whatever source derived." This definition is construed broadly and, unless the taxpayer can demonstrate that income fits into one of the exclusions provided by law, the income will be taxable. One of the exceptions is provided in Code Sec. 102, where the amount received is defined as a gift if it: comes from a detached and disinterested generosity; is made out of affection, respect, admiration, charity, or like impulses; is not made from any moral or legal duty, nor from the incentive of anticipated benefit of an economic nature; and is not in return for services rendered (Comm. v. Duberstein, (S Ct, 1960) 5 AFTR 2d 1626). Recipients may exclude payments that they receive under Code Sec. 102 if they meet the Duberstein standard. Assuming, based upon the code sections referenced above, that the funds are gifts, are the gifts subject to gift tax reporting? Maybe, depending on the amount of the contribution, the relationship between the fundraiser and the backer, and the total amount of the gifts made during the year by the fundraiser to the backer. For 2015, the annual gift tax exclusion of $14,000 is available for gifts by an individual to each donee without any gift tax concerns.
If you are someone who has received a 1099-K, things can get a little sticky. Since the IRS has provided no guidelines as to how to deal with such a situation, the 1099-K recipient will need to show the 1099-K income on their income tax return (1040) and then back it out. One method would be to include it as miscellaneous income (not subject to SE tax) on line 24 of the 1040. Then back it out, on line 24, referencing an attached explanation.
In the future, good Samaritans who set up these crowdfunding accounts should use the tax ID number of the beneficiary of the funds in order to avoid the aforementioned problems. In doing so, the beneficiary will receive the 1099-K and is in a better position to claim that the funds are a gift. Should the IRS take the position that it is income, which is doubtful, the beneficiary may be in a better position to offset the income in terms of medical deductions.