crowdfunding campaigns: tax and legal issues … · how businesses raise funding 8 •project...

10/17/2018

1

ATTORNEY NAMETitle, PracticeArea

email address

Crowdfunding Campaigns: Tax and Legal Issues

T. Joshua WuPartnerClark Hill Strasburger

1

OUTLINE

2

• What is crowdfunding?• How businesses raise funding• Traditional funding strategies• Alternative funding strategies

• Crowdfunding policy issues• Special issues with equity crowdfunding• Income tax issues for crowdfunding

• Includable in income• Allowable expenses• Gifts and donations

10/17/2018

2

What is crowdfunding?

3

• Merriam-Webster– “the practice of obtaining needed funding (as for a new

business) by soliciting contributions from a large number of people especially from the online community”

• Facts about crowdfunding– 375 = number of crowdfunding platforms in North America

– 16.2 billion = total crowdfunding volume worldwide

– 2.65 billion = total funding volume of reward crowdfunding

– 597.8 million = crowdfunding commitments in the U.S. retail sector

*Statista.com

Growth of Initiated Offerings

SEC study for Scott Bauguess (Feb. 28, 2017).

4

10/17/2018

3

Types of Crowdfunding Offerings


5

Crowdfunding Offerings by Issuer Location


6

10/17/2018

4

How Businesses Raise Funding

7

• Traditional funding

– Bank loans

– Equity investors

– Debt investors

– Friends and family

• Crowdfunding

– Project crowdfunding

– Accredited-investor crowdfunding

– General public crowdfunding (Title III of the JOBS Act)


8

• Project Crowdfunding– Fundraising party solicits money for a project and

gives “investors” something tangible or intangible in return (but not stock or debt)

– $1.5 billion reportedly pledged to Kickstarter projects, with 7.85 million total backers.

• Project (Gift) Crowdfunding– “Investors” do not expect anything in return for funds

▪ Charitable causes

▪ Medical needs for unique cases

▪ Honeymoon trips

10/17/2018

5

Crowdfunding Policy

9

• State blue-sky laws (1900s)– Designed to prevent speculative schemes that have no

more basis than so many feet of “blue sky.”– Antifraud provision for false statements made in offerings

• SEC Regulation A (1964)• SEC Rule 146 (1970)

– Limited private offerings exempt from registration with SEC

• SEC Rule D (1982)– Liberalizing exemption for certain private offerings– Defined accredited investor

• JOBS Act


10

• What is an “accredited investor”?– Certain institutional investors

– Directors, executive officers, or general partners of the issuing company

– Sophisticated or wealthy individuals▪ Net worth in excess of $1 million, or

▪ Individual income in excess of $200,000, or joint income with spouse in excess of $300,000 in each of last two years and anticipated in current year.

– Entities where owners meet above criteria

10/17/2018

6


11

• Crowdfunding by Accredited Investors (Title II)– JOBS Act created new exemption for private securities (not

registered with SEC)– Companies allowed to advertise and promote private

offerings so long as:▪ They were not raising more than $1 million over a twelve-month

period▪ They allowed only accredited investors to buy securities

• General public crowdfunding (Title III)– JOBS Act authorized businesses to sell securities in their

companies using crowdfunding even if investors not accredited

– SEC rules effective May 2016

General Public Crowdfunding (Title III)

12

• Unlimited number of investors• Must be made through funding portal (not fundraising

company directly)• If investor’s net worth and annual income are both less

than $100,000, she may not invest more than $2,000 or 5% of her net worth or income (whichever is greater) in crowdfunded offerings of securities during rolling 12-month period

• If net worth exceeds $100,000, she may not invest more than 10% of her net worth or income (whichever is less) in crowdfunded offerings

• Accredited investors are not capped

10/17/2018

7

Business Issues

13

• Choosing the legal entity– Three types for Title III

▪ Regular corporations▪ S corporations

– H.R. 531 (proposed) – Exception to 100 shareholder rule

▪ Limited liability companies

• State of incorporation– Franchise taxes on authorized shares– Shareholder rights– Voting rights– Inspection rights

Business Issues

14

• Types of securities– Notes– Convertible notes– Common stock– Preferred stock– LLC units/membership interests

• Classes of securities– Convertible preferred stock– Voting and nonvoting classes of common stock– Stock redemption rights

• Offering amount

10/17/2018

8

Business Issues

15

• Disclosure to investors / funding portals– Term sheet– Nonbinding summary– Pitch deck– Disclosure document (SEC Form C)

▪ Name, legal status of entity, date of organization, website address.▪ Officers and directors▪ Owners of 20% or more of outstanding voting equity securities▪ Description of business▪ Number of employees▪ Target offering amount▪ Use of funds▪ Etc.

Special Issues in Equity Crowdfunding

16

• Contributions to corporation– Section 351(a) provides that “[n]o gain or loss shall be

recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation.”

• Rewards– Rewards or perks from entity in addition to equity may

trigger gain recognition to extent of the FMV of the property received

• Contribution to partnership– Section 721(a) – no gain or loss for contribution of property

in exchange for interest in partnership

10/17/2018

9


17

• Worthless investments– Section 1244 allows ordinary loss on stock of small

business corporation– Section 165(a) allows deduction for loss not

compensated for by insurance or otherwise

• Small business stock– Section 1202 exclusion of 100% of gain recognized on

stock of a qualified small business (QSB) corporation held for more than five years

– Section 1045 allows investors to roll over gain realized on sale of QSB stock into stock of another QSB corporation


18

• Qualified Small Business Stock

– the stock was originally issued after August 10, 1993;

– the taxpayer obtained the shares of stock as the original holder from the corporation;

– the issuing corporation meets the domestic C corporation requirement;

– the corporation engages in an active business;

– and the taxpayer's stock was issued before the corporation's aggregate gross assets exceeded $50 million.

10/17/2018

10

Income Tax Issues - Reporting

19

• Section 6050W requires information reporting for certain payments made in settlement of payment card (e.g., a credit card) and third party network transactions (e.g., PayPal).– de minimis rule applies if aggregate payments to

the payee by the third party for the calendar year do not exceed $20,000 or if the aggregate number of transactions between the third party and the payee that would otherwise be reportable does not exceed 200 within the calendar year

Income Tax Issues - Income

20

• Under Code Sec. 61(a), except as otherwise provided by law, gross income includes all income from whatever source derived.

• A gain “constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it.” (Commissioner v. Glenshaw Glass Co., (Sup Ct 1955) 47 AFTR 162)

• Treas. Reg. § 1.451-2 sets out the constructive receipt doctrine

10/17/2018

11

Income Tax Issues - Crowdfunding

21

• IRS Information Letter 2016-0036– No cases or IRS rulings directly address the taxability

of contributions to a crowdfunding project.– Generally, money received without an offsetting

liability, that is neither a capital contribution to an entity in exchange for a capital interest in the entity nor a gift, is includible in income.

– Crowdfunding revenues generally income if they are not:▪ Loans that must be repaid▪ Capital contributed in exchange for equity▪ Gifts made out of detached generosity and without any

“quid pro quo”

Income Tax Issues – Trade or Business

22

• Section 199A

– No specific definition of “trade or business”

▪ But specific inclusion for rental or licensing of tangible/intangible property

– Proposed Regulations point to Section 162(a) and related case law

▪ Primary purpose of profit

▪ Regular and continuous

10/17/2018

12

Income Tax Issues – Expenses

23

• Deduction for “ordinary and necessary expenses” incurred in “trade or business”– Common and accepted– Helpful and appropriate– Taxpayer must show that he engaged in the activity with

an actual and honest profit objective.

• Hobby loss– Deductions attributable to an activity not engaged in for

profit are generally allowed only to the extent of incomefrom it. See Section 183.

– Deductions for hobby activities are claimed as itemized deductions on Schedule A, Form 1040.

Income Tax Issues – Hobby Loss

24

• Factors to determine if activity engaged in for profit or hobby:– Does the time and effort put into the activity

indicate an intention to make a profit?

– Do you depend on income from the activity?

– If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?

– Have you changed methods of operation to improve profitability?

10/17/2018

13


25

• Factors (cont.)– Do you have the knowledge needed to carry on the activity

as a successful business?– Have you made a profit in similar activities in the past?– Does the activity make a profit in some years?– Do you expect to make a profit in the future from the

appreciation of assets used in the activity?

• An activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses).


26

• Multiple activities– Based on facts and circumstances

– Similarity of activities

• Cases– Profit motive

▪ Barbour v. Comm’r – TC Memo 1976-85

– Businesslike attitude▪ Eisenman v. Comm’r – TC Memo 1988-467

– Records▪ Rohr v. Comm’r – TC Memo 1993-373

10/17/2018

14


27

•Exception from gross income for gift•Comm. v. Duberstein, (S Ct, 1960) 5 AFTR 2d 1626, the value of property acquired by gift is excluded if it: comes from a detached and disinterested generosity; is made out of affection, respect, admiration, charity or like impulses; is not made from any moral or legal duty, nor from the incentive of anticipated benefit of an economic nature; and is not in return for services rendered.

•Economic or other consideration?

•Quid pro quo?

•What about “rewards” for contributions?•Look to donor rules?


28

• Deduction by contributor

– Payments to Section 501(c)(3) public charity

▪ Return benefits to donor?

– Payments to individuals

– Payments to for-profit business

– Payments for credit card processing fees and administrative fees

– Issues with respect to “all or nothing” fundraising

10/17/2018

15

Special Considerations in Real Estate

29

• Trend towards private real estate investments over REITs

• Real estate deals structured through LP or LLCentities allows tax benefits to flow-through toinvestors

• Tax benefits of investing in LP or LLC deals limited to institutional investors…until crowdfunding.

• Potential benefits include depreciation, interest expense, and NOLs to offset other passive investments.

Crowdfunding & ICOs

30

• Crowdfunding intersection with Blockchain

• What do the investors receive?

– Commodity

– Equity

– Debt

– Prepaid goods

– Derivative

– Contract to acquire tokens

10/17/2018

16

Crowdfunding & ICOs

31

• SEC Asserts that tokens can be “securities”

– Treas. Reg. 301.7701-1(a)(2): “A joint venture or other contractual arrangement may create a separate entity for federal tax purposes if the participants carry on a trade, business, financial operation, or venture and divide the profits therefrom.”

– Basis?

– Are foreign tokens shares in a foreign entity?

Crowdfunding & ICOs

32

• Contracts for tokens

– Simple Agreement for Future Token (SAFT)

▪ Agreement with accredited investors for right to tokens

▪ At official launch of token, holder receives tokens based on set formula

– Tax treatment as forward contract?

– Taxable to issuer with zero basis?

10/17/2018

17

State Tax Issues

33

• Constitutional limitations

– Commerce Clause

▪ Substantial connection (nexus) with the state

▪ Fairly apportioned

▪ Does not discriminate against interstate commerce

▪ Fairly related to the services provided by the taxing state

– Due Process

▪ “Some definite link, some minimum connection, between a state and the person, property, or transaction it seeks to tax.” Miller Brothers Co. v. Maryland, 347 US 340 (1954).

State Tax Issues

34

• Nexus

– National Bellas Hess, Inc v. Department of Revenue of Illinois, 386 US 753 (1967)

– Quill Corp. v. North Dakota, 504 US 298 (1992)

– “Click-through nexus” for e-commerce

– S.D. v. Wayfair (2018)

• State guidance– Virginia

▪ 2013 House Bill 1872 noted that crowdfunding is eligible for any income tax credit for which it otherwise qualifies.

10/17/2018

18

State Tax Issues

35

• Washington State Department of Revenue issued guidance requiring project creators who raise more than $12,000 to register with department, obtain a license, and file all appropriate tax returns.– Project creator must report donations when

project fully funded for excise tax purposes.

– Project creator must collect sales tax on donations if provides retail services, digital products, or tangible personal property as rewards.

QUESTIONS?

36

10/17/2018

19

SPEAKER

T. Joshua Wu

(210.250.6078)

[email protected]

LinkedIn

37

mailto:[email protected]

crowdfunding campaigns: tax and legal issues … · how businesses raise funding 8 •project...

Documents