The IRS Office of Chief Counsel recently released Information Letter 2016-0036 in response to questions regarding the taxation of crowdfunding revenue. In it the IRS concluded that crowdfunding revenue is taxable to the extent it is received in exchange for services or property.
Further, the IRS stated that crowdfunding revenues generally are includable in income if they are not:
- Loans that must be repaid;
- Capital contributions to an entity in exchange for an entity interest in that entity; or
- Gifts made out of detached generosity and without any “quid pro quo.”
With respect to the last factor, the IRS noted that a voluntary transfer without “quid pro quo” is not necessarily a gift for federal income tax purposes. In other words, the detached generosity and intent to make a gift must still be established.
Chief Counsel also looked to the constructive receipt rules in response to questions about when crowdfunding revenue is includible in income. Those rules provide that that, even if a taxpayer does not actually possess income, it is deemed to have been constructively received by her in the tax year when it is credited to her account, set apart for her, or otherwise made available to her.
As is the goal of IRS Information Letters, the above information merely reiterates well-established principles of tax law without applying them to a specific set of facts. According to the IRS, the income tax consequences to a taxpayer of a crowdfunding effort depend on all the facts and circumstances surrounding that event.
If we attempt to apply the broad principles set forth by the IRS to common crowdfunding efforts, it is clear that many questions remain as to the tax treatment of crowdfunding. Take, for example, the actual questions posed to the IRS that prompted the Information Letter.
What are the income tax consequences of a crowdfunding effort to purchase a company through contributions for which the contributors will receive X?”
“Does the recipient have constructive receipt of the contributed funds before the funds are used to purchase the company, because those funds may have to be returned to the contributors?”
The letter doesn’t provide details as to what X is, but apparently there is some quid pro quo present such that the revenue does not appear to be excludible as a gift. However, if the property or benefit to be provided is de minimis or otherwise less than the value of the contribution, can the taxpayer claim that the contribution was in part a sale and in part a gift? The argument is certainly permissible in the context of charitable gifts. However, the donor claiming the charitable deduction must prove that they intended to make a gift of the amount donated in excess of the value of the goods or services received. Establishing this intent may be feasible for a donor, but how does the recipient of crowdfunding revenue establish the intent of the contributor? Moreover, if, as the Information Letter states, the intent to make a gift must be established even when no quid pro quo is present, is it really plausible for a recipient of crowdfunding revenue to claim they received a gift? Perhaps some situations will logically lead to this conclusion. It is also conceivable that a carefully crafted crowdfunding pitch can be used as evidence to establish a contributor’s intent, however such statement may also be dismissed as self-serving. In any case, careful consideration must be given to each situation before crowdfunding revenue is excluded on the basis that it was a non-taxable gift.
It is equally difficult in this case to claim that the revenue at issue is a loan. An advance of funds is typically only treated as bona fide debt if the obligation to repay the debt is unconditional. Here it is clear that the funds merely may have to be returned to the contributors. Furthermore, it does not appear that, in this instance, money is being advanced to a company in exchange for an equity interest in that company because the company has not yet been purchased. If X constitutes an interest in the company to be purchased, maybe there is an argument under theories of agency or trust that this was money contributed to the capital of a company in exchange for an equity interest. However, we’d need to know much more about the flow of funds and character of X.
Assuming the conclusion is that the crowdfunding revenue is taxable, it may be taxable upon receipt if the recipient has sufficient control over the funds. While the possibility that the funds may have to be returned could, in some cases, defer taxation until the recipient’s right to the income is absolute, that is not always the case. If the recipient has unfettered control over the funds in the interim, she may be subject to tax upon receipt.
In sum, while the issuance of the Information Letter grants us some insight in to how the IRS views the taxation of crowdfunding revenue, many questions remain. The IRS invites taxpayers to request private letter rulings that apply the law to the taxpayer’s particular facts and circumstance, but this is time consuming and costly. For those not willing to undergo such effort and expense, be advised to consult your tax advisor before taking a position on the taxability or exclusion of crowdfunding revenue from taxation.
The full text of the IRS Information Letter can be found at https://www.irs.gov/pub/irs-wd/16-0036.pdf.
 See, Section 1.170A-1(h)(1) of the Treasury Regulations.