Personal Finance

Some crowdfunding donors could be accidentally breaking tax laws

Key Points
  • Crowdfunding has exploded as a way of raising money for needy individuals and groups.
  • The websites may offer donors little guidance in navigating the tax implications of their gifts.
  • Legally, those who give to some campaigns may be required to file a gift-tax return.

If the spate of recent national tragedies has tugged at your heartstrings and encouraged you to donate to a charitable crowdfunding campaign, beware: you're entering dicey legal territory.

That's because, in some cases, you may be required to file a gift-tax return, even if your donation was small in size, according to Martin Shenkman, founder of Fort Lee, New Jersey-based Shenkman Law.

Charitable crowdfunding campaigns have exploded in popularity in recent years.

Pradeep Gaur | Mint | Getty Images

According to a 2016 Pew Research Center report, 22 percent of American adults have contributed funds to crowdsourced fundraising project. The market for crowdfunding is expected to grow to greater than $300 billion by 2025, according to Fundly, a crowdfunding website that promotes itself as a platform to "raise money for anything."

Yet the realm of charitable crowdfunding is a legal Wild West, and rife with pitfalls for donors and recipients.

Shenkman said the gift-tax conundrum may arise when campaigns are organized by a friend or relative of the ultimate recipient, and the recipient will not be the one who withdraws funds.

Although the gift-tax exclusion allows individuals to give up to $14,000 to a given recipient, in 2017, without filing a gift-tax return, the money must be immediately available to the recipient to qualify for this exclusion (in legal parlance, it must be a gift of "present interest"). If crowdfunding donations can't be immediately withdrawn by the recipient, they may not pass this test, Shenkman said.

"You have this absurd result, that people who are giving small dollar amounts may actually have a gift-tax reporting requirement that they may violate," said Shenkman.

Another headache for donors: their contributions aren't deductible unless they donate to a qualified organization such as a 501(c)(3) nonprofit. That means you can't deduct an amount you donated to assist with an individual's medical bills, for example. Medical fundraising is the fastest-growing category on YouCaring, a platform for "compassionate crowdfunding," according to the company's website.

Crowdfunding websites provide varying levels of assistance to donors trying to navigate tax rules.

GoFundMe maintains a list of "Certified Charities" that have been verified as nonprofits, and automatically sends donors tax receipts for contributions to campaigns that benefit one of those charities. But the platform also allows recipients not on that list to describe their campaigns as a "charity" on its website.

With a lot of these websites it's very easy to feel good donating money. But whether you're doing good can be unclear.
Daniel Borochoff
founder of CharityWatch

The website of Generosity, a platform for "socially conscious fundraising" owned by Indiegogo, states that donors should contact campaign organizers to determine if donations are tax deductible. The website advertises campaigns that claim to benefit registered nonprofits alongside campaigns that make no such claims.

Donations can even create unintended headaches for recipients.

If a beneficiary receives means-tested government benefits such as Medicaid or Supplemental Security Income, then receiving a large cash inflow from a crowdfunding campaign could cause him or her to lose government benefits, said Jonathan Blattmachr, a principal at Pioneer Wealth Partners in New York and director of estate planning for Peak Trust Company. That could mean that, for example, funds from crowdfunding pay for medical expenses that Medicaid would otherwise have covered.

"You might think you're helping the recipient, but you're actually hurting her," Blattmachr said.

Raising funds on behalf of a supplemental or special needs trust, for individuals seeking help with medical bills, would circumvent the problem, Shenkman said.

Perhaps the biggest problem for donors, however, is the difficulty in evaluating whether funds will actually be used for the purposes described in a crowdfunding campaign's pitch.

GoFundMe, Indiegogo's Generosity and YouCaring all have procedures in place to guard against misuse of their platforms, according to spokespersons for each of the companies. But it's impossible for crowdfunding companies to thoroughly vet every organizer and recipient who uses their platforms, said Daniel Borochoff, founder of CharityWatch.

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"It's convenient, and it's powerful because you can reach a lot of people quickly, but whether or not the money actually goes to its intended purpose is certainly not guaranteed," Borochoff said.

Borochoff said donors should only contribute to a crowdfunding campaign if they trust the organizer, such as if it is someone they personally know or a respected community leader. If donors want to contribute to a non-profit organization, they should do so directly through the organization itself rather than through a crowdfunding website, which may collect its own fees from donations, he said.

In contrast to crowdfunding campaigns, Borochoff said, tax-exempt nonprofits are subjected to oversight by a board of directors and by regulators, and must submit annual filings to the Internal Revenue Service. Traditional nonprofits may also have more experience in vetting potential recipients, he said.

"With a lot of these websites it's very easy to feel good donating money," said Borochoff. "But whether you're doing good can be unclear."