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The Taxman Cometh: Tips for Navigating the Tax Consequences of Crowdfunding Money

Congratulations, your 2014 startup campaign was a HUGE success and you raked in gobs of money.  Now, with the new year here and tax return deadlines slowly approaching, will you be prepared to pay taxes on all those receipts? While crowdfunding is a great way to raise money for projects, ventures, films, music, or charities, most crowdfunding campaigners are totally unaware of the tax consequences of their campaigns. Here are some tips.

Crowdfunding Money as Income. Generally, the IRS takes the position that all income (if characterized as income) is taxable.  Although it may come as a surprise to crowdfunding campaigners, money from crowdfunding sites can generally be considered taxable.  In fact, if you raise more than $20,000 on Kickstarter from more than 200 people, you’ll get a Form 1099-K (a new tax form introduced  and required for third-party payments above that threshold), courtesy of Amazon Payments, which processes transactions for the site. Indiegogo, which allows pledges by PayPal or credit card, notes in its agreement that users “shall have full responsibility for applicable taxes” on their projects’ funding.

Sales vs. Non-Sales. If you are thinking of crowdfunding, here are some quick tips for you.  If you are selling something where money is given to you in exchange for a “thing,”  it is taxable. For example, if a crowdfunding campaign uses a site to raises money to develop a new accessory, video game, or other product or service,  the proceeds you receive will be considered income and is therefore taxable.  Just because the funds are taxable, though, doesn’t mean you’ll actually owe tax on them. If your business expenses are higher than the money you bring in, you may not owe anything. It’s going to depend on the deductibility of your expenses. Not all expenses are deductible, and some must be deducted over time (i.e., depreciated).

Crowdfunding Money as Capital Contributions. On the other hand, there are situations in which crowdfunded pledges may not be taxable. Some may be considered gifts, others donations. Once the JOBS Act, which allows startups to solicit investors online as a way to encourage funding of small businesses, takes effect, some contributions may be considered “capital contributions,” and not taxable when they’re received. However, the rules on what is and is not a capital contribution is complicated, and you’ll need professional tax advice to makes sure the tax man does not show up at your door.

Crowdfunding Money as Gifts.  On the third hand, there are also situations where crowdfunding  money is better described as a gift than income. A gift is a contribution in which the giver gets nothing in return. Gifts are not taxable to the recipient, and gift givers are allowed $13,000 a year per recipient tax-free.  Money given to nonprofits, animal rescues, and other charitable endeavors can often aptly be considered a gift instead of income to the campaigner, but again, the rules are complicated and professional tax advice should also be utilized.  Generally, gifts arise out of generosity, not a moral or legal obligation, and are not given with the anticipation of receiving a return.

Sales Tax.  Finally, it is important to remember that sales tax must be collected on tangible goods, except in specific items enumerated by law such as prescription drugs. This means every campaign sending products of any kind (i.e., phones, novelties, t-shirts, etc.)  is require to pay sales tax, if the person receiving the item lives in the same state.

Taxes and Deductions. Also worth mentioning is the fact that a crowdfunding campaigner will usually be responsible for paying taxes on the entire amount obtained through the site, not just what was actually received after the crowdfunding site and its payment processor take as their shares. So, if a startup does not spend all of its crowdfunding money on deductible expenses in the same tax year that the funding is received, you will need to budget for the tax burden.  This makes it a good idea to run campaigns earlier in the year.

Personal v. Business. Finally, consider whether you should create an LLC or Corporation before you set up a crowdfunding campaign.  Many crowdfunding sites will require you to provide your social security number / tax ID to create the account so that they can pay you. If your campaign is funded, the entire amount will be taxable to you personally — and there are a lot fewer deductions that individuals can take rather than corporations. Also, payment processing sites (like Amazon Payments) often refuse to update your payment receipt information once any money hits your campaign…. which could leave you with a big tax bill.

Getting Advice Early. The best way to avoid a tax headache? Get professional advice BEFORE running your campaign, if it is a serious venture, but most of all, have fun! Crowdfunding is an exciting way to get a company or venture launched off the ground quickly. With a little planning, it can be a little less stressful.

AXIS Legal Counsel’s Startups Practice provides legal advice to numerous startups at the pre-seed, seed and growth stage, including investor-backed ventures.  AXIS  can help with formation matters, governance, co-founder’s agreements, insurance, licensing, and assist with investment agreements, convertible notes, tax elections, and numerous other matters that startups deal with, including startup formations, contracts, deals, and transactions, business administration, corporate governance, operations, risk management / insurancelabor/employment matters, intellectual property, healthcare, crisis management, directors/officers, private/data security, technology, statutory/legal compliance, and business litigation. AXIS represents California and Delaware startups, C Corps, S-Corps, LLCs, LLPs, Partnerships with a wide variety of legal tasks.    For information on retaining AXIS Legal Counsel to represent your startup in connection with any legal matter, contact [email protected] or call (213) 403-0130 for a confidential consultation.