Crowdfunding Taxation

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Taxable Income

Funds raised through crowdfunding platforms like Kickstarter and Indiegogo are typically classified as income for tax purposes, but can usually be offset by project-related expenses. Most crowdfunded projects do not make much of a profit, using up most or all of the funds earned from crowdfunding to pay for manufacturing and production expenses. In doing so, you can reduce your total amount of taxable income.

This offsetting of expenses to minimize the tax burden works out easily if you obtain your funds and incur all of your expenses in the same calendar year. But if you receive funds this year and continue to work on your project and incur expenses into the next year (starting in January), those later expenses will not offset income from the funds you received and you’ll have higher tax liability this year. Consequently, you’ll have less total cash on hand to put toward your project.

What’s a crowdfunding recipient to do? Here are some possible strategies:

• If you run your crowdfunding campaign earlier in the year, e.g. by crowdfunding in January, you can have close to 12 months of runway, maximizing the amount of time to use up your funds for the project and offset your income.
• If you form an C-Corporation or an LLC electing to be taxed as C-Corporation, you may choose the timing of your fiscal year and strategize around when you crowdfund. Note however, that if you wish to change the timing of the fiscal year later, or if you already have an entity and now wish to change your fiscal year before crowdfunding, you have to file a change request with the IRS and meet certain criteria, and in some cases you may be required to pay a fee.
• If you do have funds left over at the end of the year, don’t despair -- there is another way to postpone paying taxes. By electing Accrual Accounting, you can claim income when you actually earn the money - e.g. when your mini 3D printer is produced and distributed to the people who pre-ordered via Kickstarter. The tax paperwork can get a little tricky, and requires not just choosing Accrual Accounting, but also specifically electing to classify the income in this way.

Other Tax Saving Strategies:

• R&D Tax Credit - This credit can apply to up to 13% of eligible spending for research and experimentation to develop a technological product or process. So something like a mini 3D printer or an innovative app could qualify, whereas artistic undertakings like producing a film probably would not.
• Domestic Production Activities Deduction - Products made in the USA, including tangible goods, computer software, films, and sound could qualify for a pretty nice tax deduction of 9% of gross adjusted income. There are several requirements - more details and guidance from the IRS here.

Non-Taxable Gifts

Some crowdfunded projects may be able to classify the funds they receive as non-taxable gifts under Internal Revenue Code 102. A “gift” is something given out of disinterested generosity, without an expectation of receiving anything in return. The U.S. Supreme Court has given some guidance in Commissioner v. Duberstein 363 U.S. 278, 285 (1960), emphasizing that the gift-giver’s intention is a key factor. The IRS website’s FAQ’s defines a gift as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return.” An “individual” typically denotes a single natural person, not a group or business entity, but can also include “artificial persons” such as a corporations.

So there is some ambiguity as to whether a business entity could receive a non-taxable gift, but arguably it could. If a crowdfunding contribution qualifies as a gift, a contributor may give up to $14000 per year to a single recipient without being subject to the federal gift tax.

A crowdfunding campaign that takes contributions without offering any perks or rewards to the funders would be most likely to have the funds qualify as non-taxable gifts rather than income. When any perks or rewards are involved, we enter more of a legal gray area.

For example, say you give a thank-you t-shirt worth $10 for a $100 contribution to create your mini 3D printer.

You might argue that according to the IRS’s description, you are not receiving full consideration in exchange for your contribution and therefore you simply gave a $100 gift. The thank you t-shirt is merely a gesture of gratitude, a gift to the contributor. However, with tiered levels of rewards for different levels of contributions, it starts to feel a bit like the contributor is at least partially incentivized by the reward structure. Moreover, in the non-profit realm, when a charitable organization receives a tax-deductible contribution and gives the contributor a thank you gift, there is an established method of accounting: the cost of the gift is deducted from the gift amount. So in our example, you might assert that of the $100 you received via crowdfunding, $10 was income in exchange for the reward t-shirt (offset entirely by the expense of the t-shirt) and $90 was a non-taxable gift. The IRS has not issued a clear ruling in the crowdfunding context, and although this practice would be consistent with a the established practice in the non-profit realm, it is not guaranteed that this accounting method would be upheld in this context. It gets even trickier when the value of a reward is harder to quantify. How much is it worth to a contributor to have their name on a plaque? An intangible reward for a crowdfund contribution might not be a sale or transaction at all -- the gift may be free and clear, but again, the IRS has not given us much guidance.

If you are a 501(c)(3) non-profit raising funds, note that many crowdfunding platforms do not permit tax deductible charitable donations through their platforms, so non-profits should consider running their own campaigns or find a platform that is qualified to facilitate funding for charitable organizations.

Sales Tax

Don’t forget that in California, New York, and several other states, sales tax may apply! And not just on your final product, but on those t-shirt and sticker rewards for contributors too... check into tax resources for your state.