Receiving free money can cost you a lot.

I tend to think of myself as a glass-half-full type of gal. I mean sure, I've had days where it seems like one thing after another, after another, after yet another has gone into the crapper, just like everyone else. And even though I've experienced my fair share of heartache over the years, I feel I've been dealt a pretty decent hand in life.

I try to pay it forward as best I can, whether by doing volunteer work or donating clothing and household goods to those less fortunate. I’ll even drop $1 into the glass jars while at the grocery store. And if a neighborhood kid is selling chocolate bars for a buck, heck, you better believe I’ll do my part. And it appears you guys are doing your part as well.

The rise of crowdfunding

According to Crowdsourcing.org, in a Crowdfunding Industry Report created by Massolution, in 2012 alone over $2.7 billion was raised through sites like GoFundMe, GiveForward, and YouCaring. This fund raising frenzy is called crowdfunding, and in 2013 that number jumped to a whopping $5.1 billion. That, my friend, is a lot of chocolate bars! But what exactly is this crowdfunding, and how does it work?

It’s pretty simple actually. In just a few short minutes anyone with a computer, smartphone, or tablet can create an account on one of these sites, then post a link on social media (or anywhere else for that matter) asking “the crowd” (us) to make donations to their cause. It’s a great way to reach a lot of people at once, especially in a situation to help a family in need with a medical, funeral, or emergency type of expense.

However, since these types of programs are fairly new, the rules on how to handle the taxes are still a bit vague. Do you have to claim the funds as income, or does it fall under the IRS annual gift tax exclusion? GoFundMe's website, for example, states that “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 US”. They follow up with suggesting you consult with a tax specialist.

Is the money considered income or a gift?

This is where it gets tricky… If you ask two tax professionals, one will say it falls under income, while the other will say it’s clearly a gift (as long as is does not fall under any form of a doing business definition). There is nothing that clearly states in writing how to handle this type of phenomenon. It’s too new. It can be interpreted differently by different people. Is it black and blue or gold and white? So what do you do?

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 the required information, and your bank account to complete the registration. Not to worry, once the money transfers into your account you can make a withdrawal and give it to her. Why did you do it this way instead of getting her bank information? Who knows. 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, and many $25-$500 donations trickling in, you have raised a little over $15,000. You transfer the funds to your bank, and have a cashier’s check made payable to your friend. As you hand it to her, she’s all smiles. You are too, until you later realize you may get stuck with the tax bill.

You see, all of the individual donations flew under the $14,000 limit radar set by the IRS (remember what we discussed above?). Even the total of $15,000 would have been fine since no one person gave over $14,000 individually. Well, except you…when you presented the $15,000 total amount. Unless your tax preparer can find some loophole, you may get stuck with the whole tab. (Loophole example: If you are married, part of the $15,000 funds could be considered to be a gift from your spouse).

Are your benefits at risk?

Does it matter if you have to claim the money as income and pay a little tax on it? I mean it was ‘free’ money after all, right? Well, it can matter quite a bit. A whole bunch in fact. Especially if you are receiving disability, social security, a health insurance tax credit, or any other type of income based assistance. The extra income from one of these innocent-enough fund raisers may well throw you over the income limit for your assistance. So before you start your own online fund raiser, make sure it won’t ultimately diminish your livelihood.

How do the funds get reported to the IRS?

I did find it hard to believe that someone would be able to raise, let’s say $50,000, from one of these sites, and the IRS be completely fine with not collecting any taxes whatsoever. And as luck would have it, I was correct, or at least partially correct. 

Typically the crowdfunding sites use payment processors to process, well, the payments. Those processors, not the fund raising sites, are the ones that send tax forms to the recipient and IRS. However, these processors are not required to send reports unless the amount reaches $20,000, and 200 or more transactions have occurred during the year. If both of these events happen, a 1099 form will be generated. While there are still many grey areas, some limits are beginning to be put into place.

So why is the IRS picking on some poor person named Earl from Mishawaka, Indiana (it’s a place, really, I looked it up) that we’re just trying to help raise $20,000 for a kidney transplant? Well, because those fund raising sites can’t verify what the funds are really being used for, and the payment processors don’t cut a check to the kidney transplant joint. For all the IRS knows, or us for that matter, those funds are going to buy $20,000 worth of gumballs and gummy bears.

Don’t get me wrong. I am not against crowdfunding. Actually I think it’s an amazing way to show generosity to those in a time of need. It’s much more convenient than giving a gift card, especially if you don’t live in the same area. In addition, the ability to use a credit or debit card is preferred over sending funds directly to an account established at a local financial institution. I just think it’s important to be aware of the full range of consequences that can transpire.

So before setting up a crowdfunding campaign to benefit you, or someone else, make sure you aren't costing yourself more than you’re raising. I’m not sure how well a GoFundMe campaign “to pay my taxes from my previous fund raiser” would go over with many donors… 

Disclaimer: In case I haven't made it clear...consult a tax specialist. I'm not one. I don't hold myself out to be one. Don't sue me~ 

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"Image courtesy of Stuart Miles, published on 08 October 2013 Stock Image - image ID: 100206682  FreeDigitalPhotos.net"