Crowdfunding platforms, such as Kickstarter, open a whole new world in business financing, but can end up being a confusing world for tax purposes. The proceeds aren’t like sales in the traditional sense, and the people who contribute are not stockholders. So, how should you handle income from a crowdfunding project?
It’s important to report crowdfunding income correctly, or the IRS is likely to make sure you do.
Here’s what you need to know to stay out of trouble with the IRS – and other taxing authorities.
Crowdfunding proceeds are taxable income.
Generally crowdfunding proceeds must be reported as income in the year you receive them, or they are constructively available to you.
If you are using the accrual basis, you must report income when you earn it, at the time it is due to you or when you receive it, whichever comes first.
Using the accrual method does not allow you to postpone the recognition of income you have received.
Some people argue crowdfunding proceeds are gifts. However, if you don’t know the people contributing, and they receive something of value in return, that’s going to be a difficult argument.
Most crowdfunding deals offer bigger items in return for larger “donations,” which makes the gift argument even less tenable.
But, there may be a few situations where crowdfunding can be considered a gift. Although, people seldom make gifts to for-profit businesses, so if you want to argue the proceeds were a gift, you’ll need to make a convincing case.
On the other hand, if the proceeds were actually gifts, the donors are responsible for any gift tax returns.
You may owe state sales tax and income tax.
If you accept crowdfunding proceeds from the state you operate in, and that state has a sales tax, you may need to remit sales tax.
The same goes for income tax. Check with your state to be sure.
You can deduct expenses from income.
A business that uses crowdfunding is still a business like any other when it comes to taxes. You report income and offset that income with expenses.
If you raised the amount of money you expected to spend developing a product, and you spent exactly that, your net income from this business should be close to zero.
You may even have a deductible business loss if your expenses exceed your income.
You may be able to deduct start-up expenses in the year you paid them.
Some expenses for investigating the creation of a business or the actual start-up costs for a new business are not ordinarily deductible in the year you paid them.
For example, the expenses of market surveys, advertising a business opening, legal and other professional services and training employees before the business starts are considered start-up expenses. Most expenses you pay before the day your business opens are start-up expenses.
While start-up expenses are generally considered capital expenditures and therefore amortized over the course of 180 months, the IRS does allow you to deduct up to $5,000 in the year the business begins.
That $5,000 is reduced dollar-for-dollar by your cumulative start-up expenses in excess of $50,000.
Additional costs that are not start-up expenses include taxes, interest and research and development costs.
Research and development costs merit special tax treatment.
Research and experimental costs are generally your expenses to develop or improve a product. You can choose to amortize research and development costs over 10 years, or deduct them in the year you have the expense.
Research and experimental costs do not include such items as consumer surveys or advertising. Instead they include costs related to the invention, patents, pilot models, etc.
Beware of raising crowdfunding proceeds late in the year.
What happens if you raise a ton of Kickstarter income late in the year, but don’t have significant business expenses until the following year?
The answer: you just made taxable income.
The problem: you can’t report the income for the following year, nor can you deduct next year’s expenses early.
Your income and expenses are in different years, which could be a tax disaster. Your taxable income with no offsetting expenses could push you into a higher income tax bracket, and the resulting tax could take a large portion of the money you expected to use for your project.
The following year, if you have large business expenses, but little to no business income, you may have a deductible business loss. Depending on the rest of your total tax picture, this may make up for your big tax bill the first year.
The best advice is to avoid such a scenario. Make sure you plan crowdfunding projects so you receive proceeds early enough in the year that you can match most of your expenses to your income.