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Crowdfunding Your Entrepreneurial Dream Could Come With Tax Complexities & Surprises

Do you run crowdfunding campaigns to enable your business ventures and entrepreneurial dreams? With the new 1099-K rule, crowdfunding might just come with tax complications

What is crowdfunding?

Crowdfunding is a funding process where individuals can contribute variable amounts of money with no fixed threshold for a cause or an entrepreneurial purpose they believe in.  If you own a startup that needs funds for a marketing campaign, crowdfunding is one way to go.

Alternatively, if you’re just starting out and need funds to launch your business, crowdfunding can be a great tool to raise funds for your entrepreneurial dream.

Either way, a crowdfunding campaign’s main purpose is to fund your cause through multiple individual sources that are willing to donate through a common medium – the crowdfunding app or platform.

Most donors also enjoy a tax deduction on select crowdfunding campaigns (especially if the cause is a charitable one).

Crowdfunding is a very broad term, and the individual use cases of the campaign influence whether the fund generated is taxable.

According to the IRS, if a business or a person raises funds through a crowdfunding app or website, and the payee is under no legal obligation for repayment, then such funds are considered income. The payee will be taxed for the same.

What’s the new 1099-K rule?

Crowdfunding apps and websites are usually required to file a 1099-K if the gross total of the “payments” processed is more than $20,000 and if the total number of transactions is 200 or more.

However, this rule is no longer applicable for calendar years after 2021.

The IRS instructs taxpayers to file a Form 1099-K if the gross total of the reportable third-party payment transactions is $600 or more, with no limitations or reservations on the number of transactions.

This is the current 1099-K reporting regime that all third-party entities, which includes crowdfunding entities, must also follow to comply.

If the total reportable funds distributed to the business is over $600, then the crowdfunding entity needs to file a 1099-K form.

How does the new $600 rule impact crowdfunding?

Previously, the crowdfunding apps or entities didn’t need to worry about reporting with Form 1099-K unless the reportable payments threshold exceeded $20,000 with the prequalification of 200 transactions.

This quickly changes with the current 1099-K reporting regime.

Not only do crowdfunding apps need to file a 1099-K form for each payee to whom they’ve “paid” $600 or more, but the payee is also subject to pay the tax on the “income” received.

Technically, funds raised for a personal cause or a business cause through a third-party app is income and the IRS requires the payee to oblige with the voluntary compliance program and pay the taxes.

The purpose of the crowdfunding campaign, repayment obligations, and the nature of the payment are all considered when determining if the fund received is subject to federal tax.

For example, if you receive the funds to raise “capital” for your business, or if you’ve received the funds as “gifts”, or if you’ve received funds as “loans”, then such funds are obviously excluded from taxes.

What your app-based crowdfunding entity can do to comply?

Managing a crowdfunding entity is not easy.

With the new 1099-K rules in action, you will need advanced tax compliance and regulatory reporting solutions to prepare and file 1099-K forms.

Onboard customers confidently, verify their identities in real-time and report the funds distributed through your crowdfunding app on Form 1099-K with Tax1099.

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