Regulation and Tax Implications of Crowdfunding
There are three distinct types of crowdfunding:
- Reward-based crowdfunding
- Donation-based crowdfunding
- Equity-based crowdfunding (also known as regulation crowdfunding)
In regards to equity-based crowdfunding, the SEC adopted rules in October 2015 to permit companies to offer and sell their securities through crowdfunding. These rules went into effect in May 2016. Anyone can invest, however there are limits to how much someone (together with their spouse) can invest. For any 12-month period, the limitations are:
- If either annual income or net worth is less than $100,000 a year, the maximum someone can invest is the greater of $2,000 or 5% of the lesser of annual income or net worth
- If both annual income and net worth are $100,000 or more, then the maximum someone can invest is 10% of the lesser of annual income or net worth
- The maximum one person can invest in a 12-month period is $100,000
- The securities cannot be resold for 12-months except to an accredited investor
If companies want to crowdfund their securities, they can do so on portals (online platforms), which must include educational information and communication channels. Through the portal, the issuer makes required disclosures available to the public for a minimum of 21 days before any security may be sold in the offering. The maximum amount to be raised in a 12-month period cannot exceed $1 million.
There is certain information that the issuer must inform possible investors of, including:
- General company information
- Names of directors, officers, and 20% owners (if applicable)
- Intended use of proceeds and issue price (and method for determining the price)
- Target offering amount and deadline
- Certain related-party transactions
- Financial condition of the issuer
There are also certain requirements from the issuer depending on how much money is planned on being raised:
- $100,000 or less – tax return and financials certified by an executive officer of the company
- $100,001 to $500,000; or more than $500,000, but first time issuer – financial statements reviewed by a CPA
- More than $500,000 (non-first time issuer) – audited financial statements by a CPA
If there are any material changes during the offering period, the issuer must get investor recommitment within 5 days of filing an amendment. Certain businesses, including non-US companies, investment companies, and companies without specific business plans.
While the IRS and Congress has not addressed the tax implications of crowdfunding income specifically, applying common tax principles and common sense will get the taxpayer to a well-reasoned and substantiated position. While donation and equity-based crowdfunding do not have tax implications for the issuer, reward-based crowdfunding does. Amounts received through reward-based crowdfunding are usually taxable. Assuming that the crowdfunding activity is a trade or business and not a hobby, any expenses are deductible against income raised. However, if the expenses are categorized as start-up costs, the taxpayer must capitalize these costs unless an election is made to expense a portion of the costs.
Taxpayers who are thinking of starting a reward-based crowdfunding campaign should take note of the timing of the campaign. If income is taxable in one year, but the related expenses, which usually occur after a crowdfunding campaign has been completed, occur in another year, there is a timing issue. Creators should plan to end their campaigns early in one year, so they have time to incur expenses that would offset their income for the campaign.
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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.