The advent of crowdfunding and the concurrent dramatic expansion in non-profits in both the United States and around the world, has presented many business owners with more than a few not-so-easily-answered questions. At last report, Kickstarter, the leading crowdfunding destination site on the web, has collected more than $3.5 billion for nearly 400,000 projects since 2009.
Many crowdfunding sites don’t accept donations for the traditional kinds of projects non-profit organizations manage. But the truth is that Kickstarter and other crowdfunding sites like it have demonstrated that individuals and businesses are willing to put up funding for a wide variety of causes – provided they are sufficiently motivated to see the project succeed. Even if the sites don’t encourage non-profits to crowdfund, it doesn’t change the fact that there are likely many people who would be willing to contribute.
But complex questions arise when a not-quite non-profit wants to get in on the action. Can someone donate to a for-profit enterprise? How is that donation handled legally and financially? How does it affect the tax situations of the contributor and company? How can a for-profit company solicit donations without looking like they are either performing the digital equivalent of panhandling or staving off bankruptcy?
The answers to these questions are all related. So it is necessary to take a step back and define exactly what all these different situations mean before we can determine the practical answers.
From a contributor’s standpoint, crowdfunding is not all that different from straightforward capitalism. A group of investors gets together, pools their capital and forms a company or project with it. The difference between a crowdfunded project and a capitalized business is the “investors” or contributors receive no shares in the new company.
From the business point of view, crowdfunding is more like offering a pre-order than it is a round of capital. There are two reasons for this. First, the amounts in question in a typical crowdfunded project are minimal. Very often new companies and projects will offer contribution tiers in the single digits. The justification for this is an emphasis on the number of contributors rather than seeking high buy-ins.
The second reason businesses see crowdfunding as more of a pre-order is because the rewards offered to their contributors often center around the product or service being proposed as the reason funding is needed. If someone contributes to a new board game, for example, the reward for their contribution is very often a copy of the game itself.
From a legal point of view, crowdfunding does not qualify as a securities offering because no shares in the company are being solicited. Were shares being made available, it would qualify as a securities offering and there would be voluminous regulatory hoops the company would need to jump through. Crowdfunding bypasses this requirement because ultimately, the money offered is a gift. The contributor is promised nothing other than a minimal one-time reward, and there isn’t legally any contract to deliver even that much.
Since a contribution in these circumstances is legally a gift, then it would seem any organization would be in a position to solicit donations. However, there’s one more issue to consider.
The chief strength of a non-profit organization is the fact that IRS regulations permit individuals to deduct contributions to a non-profit from their taxable income.
This process is governed under Title 26, section 501 of the United States Code. This law and several others apply certain criteria to an organization seeking non-profit status. It also obligates any such organization to perform certain acts and file appropriate paperwork with various government authorities at both the federal and state level.
An organization that does not meet the requirements for a non-profit can still accept donations, but they can’t promise their contributors any tax benefits as a result of making such donations. Legally, those funds would be considered gifts, and would likely not qualify as a deduction for the contributor.
The organization accepting such a donation would also likely have to pay taxes on it as if it were regular income. This would be true for any crowdfunding income, so it is almost certain it would apply to any donation or contribution, even one that took place outside the scope of a traditional crowdfunding campaign.
Naturally, if a company’s accountant is on the ball, they could make a credible case that any products or services offered to contributors could be deducted from the business’ income as expenses arising from the campaign. While this would mitigate the tax bill somewhat, the status of the original funds wouldn’t change.
It has become clear in the last decade that businesses can not only take advantage of crowdfunding, donations, contributions, and pre-orders like any other organization – but they can do so for a variety of purposes. Even if certain crowdfunding sites restrict project types, there is nothing stopping any company from soliciting donations on its own, even for a purpose traditionally associated with a charity or a non-profit.
Nonprofits with the appropriate tax status, naturally, can continue to take donations and offer tax deductions to their contributors as well.
The key to understanding the specifics of any one situation is recognizing the legal status of the money transfer. Is the contributor getting something in exchange? Then it’s a pre-order. Are they deducting the money from their taxes? Then the organization has to be a non-profit with the appropriate tax classification. Is the contribution being solicited by a for-profit company, but meant for a quasi-charitable purpose? That’s a situation that should probably get the once-over from both a business attorney and an accountant just to make certain there is no confusion on the part of the contributor.
As long as funds aren’t being solicited for one purpose and then used for another, there is little in the way of a legal hazard. That said, it is always good advice to consult a qualified business attorney before engaging in transactions with the public that might lead to uncertainty or confusion. The potential penalties for getting it wrong are too burdensome when compared to the relatively trivial cost of finding out for sure ahead of time.