Raising Money Through Crowdfunding? Don’t Forget to Include It on Your Taxes

crowdfunding donations
Dave Dugdale under Creative Commons

My community pulled together recently to help a young father battling cancer for the second time. A local cupcakery held a fundraiser in his honor and donated $1 to his family for each cupcake sold on a particular day. The store was packed, the lines were long, and the cupcakes sold out quickly — well, at least the triple-chocolate cheesecake ones did.

When it comes to raising money for a cause, what used to be as simple as putting out a donation jar has been made even easier — you can ask people to donate right from their smartphones through crowdfunding sites like GoFundMe, GiveForward and YouCaring.

But does that help actually hurt you when it comes to tax time? As the recipient, do you need to claim the funds you raise through a crowdfunding campaign as income, or is that money considered a gift?

The Rise of Crowdfunding

Crowdfunding has come a long way from its roots in community-focused fundraisers. In just a few short minutes, anyone with a computer, smartphone or tablet can create a crowdfunding campaign, then post a link on social media asking “the crowd” (us) to make donations to their cause.

Crowdfunding campaigns can be a great way to reach a lot of people at once, as donors will often share the link with their own networks. While most people are familiar with crowdfunded business projects through sites like Kickstarter, crowdfunding is increasingly popular as a way to help cover medical or emergency expenses.

And these campaigns are indeed raising a lot of funds. In 2012 alone, these sites helped people raise more than $2.7 billion, and in 2013 that number jumped to a whopping $5.1 billion, according to a Crowdfunding Industry Report created by Massolution.

As a certified credit counselor, I was delighted to hear about crowdfunding platforms, as this is just the kind of assistance that a family needs to help them avert a bankruptcy in a time of desperation. However, my more cautious registered investment advisor side suggested a crucial question to consider before you start your own crowdfunding campaign:

Is Crowdfunded Money Considered a Gift or Income?

The rules on how to handle the taxes on crowdsourced donations are still a bit vague. Do you have to claim the funds as income, or do they fall under the IRS annual gift tax exclusion ($14,000 for 2014 and 2015)?

“While this is no means a guarantee, most donations on GoFundMe are simply considered to be ‘personal gifts’ which are not taxed as income in the U.S.,” says the company. However, they also suggest you consult with a tax specialist for advice on your situation. YouCaring takes a far more conservative approach by stating they provide “no advice” on how you should classify the funds.

Here’s the tricky part: If you ask two tax professionals, you’ll likely get two different answers. Because crowdfunding donations is still a new concept (at least, it’s become popular more quickly than tax law could be clarified), there’s no clear written directive on how to handle this money. The current rules can be interpreted in different ways, depending who you ask. Is it black and blue or gold and white?

An Example of the Potential Problems

Let’s say your dear friend’s house catches fire. Being the kind person you are, you decide to set up a crowdfunding campaign for her and her family. You enter your bank account information to complete the registration, thinking that you’ll collect the donations, then transfer the money to your friend.

Why did you do it this way instead of getting her bank information? Maybe she was busy. Maybe you wanted to surprise her. Maybe you knew she would discourage you. Whatever the reason, it happens.

After a couple of weeks, quite a few donations have trickled in and you have raised a little over $15,000. You transfer the funds to your bank, and get a cashier’s check made payable to your friend. As you hand it to her, she’s all smiles. You are, too — until you realize you could be stuck with the tax bill.

Why? All of the individual donations flew under the $14,000 annual gift tax exclusion limit. Even the total of $15,000 would have been fine, since no one individually gave over $14,000. Well, except you… when you presented the $15,000 check.

Unless your tax preparer can find a loophole, you may be stuck paying taxes on the whole tab. (Here’s one example of a potential loophole: If you are married, part of the $15,000 could be considered a gift from your spouse.)

The Impact of Counting Crowdfunded Money as Income

Does it matter if you have to claim the money as income and pay a little tax on it? After all, it was “free money,” right?

Well, if you receive disability, social security, a health insurance tax credit or any other type of income-based assistance, it can matter a whole lot. The extra income from one of these innocent-enough fundraisers could push you over the income limit for your assistance — making you ineligible for the program and adding additional financial stress to your life. Even if you’re not eligible for one of these programs, this additional income could bump you into a higher tax bracket, which could cancel out some of the funds raised.

Before you decide to launch a campaign for yourself or a friend, make sure it won’t ultimately diminish your livelihood or theirs.

Another potential impact is a more complicated tax return. Crowdfunding sites generally use a payment processor like PayPal to handle the donations, and PayPal is responsible for reporting information to the IRS on payments of $20,000 or more made up of 200 or more transactions, which creates a 1099-K form. If you earn other income through PayPal, perhaps from an online business, that income could be combined with your crowdfunded money to create a bit of a financial mess.

This is a lesson Jay Lake, a science-fiction author, learned the hard way. Friends and family raised a hefty $48,000 for an experimental process to aid in Jay’s colorectal cancer treatment via a YouCaring.com campaign. When Lake received his 1099-K form from PayPal for his book royalty income, he was surprised to see the donated funds included as income as well.

While Lake has an accountant to work through his taxes, she has warned that the commingled funds mean his tax return will likely be audited — not exactly something he wants to face while undergoing treatment for cancer.

Why the IRS Cares About Crowdfunding Income

First, look back at those numbers I mentioned earlier. The IRS isn’t likely to skip collecting taxes on the billions of dollars crowdfunding campaigns raise each year.

One reason is that crowdfunding sites and payment processors can’t verify where the money goes. Since PayPal sends the money to the person behind the campaign, the IRS can’t verify that those donations are really going to support a kidney transplant. For all the IRS knows, that money could be used to buy $20,000 worth of gummy bears.

Consider the Tax Impact Before Planning a Crowdfunding Campaign

Don’t get me wrong; I’m not against crowdfunding. I think it’s an amazing way to show generosity to those in a time of need. It’s more convenient than sending a gift card, and simpler than setting up an account at a local bank.

But before setting up a crowdfunding campaign, make sure you aren’t costing yourself more than you’re raising. A follow-up GoFundMe campaign to “pay my taxes from my previous fundraiser” might not go over well with your donors.

Your Turn: Have you run a crowdfunding campaign? Did you consider this question before launching it?

This post does not constitute tax advice. For specific advice, please see a tax professional.

Michelle Kuehner is a Registered Investment Advisor Representative and Director of Operations for Personal Money Planning. She is also a Certified Credit Counselor and Certified Financial Health Counselor, writes The Money Diet blog, and has over 22 years of experience in the financial industry.