A Simple Guide for Startup's on Crowdfunding & Taxes
Crowdfunding is rapidly turning into the most popular way to receive finances and resources for personal projects and company means that are simply too expensive to handle on our own. In fact, it’s likely that you have heard of kickstarter.com, indiegogo.com, or gofundme.com even if you haven’t personally used them.
What does this all mean?
It means fundraising has become widely popular and are receiving a lot of attention for their productive and successful revenues. However, there is something that every crowdfunding user should know, but unfortunately, doesn’t receive the inside scoop until it’s far too late, and that has to do with taxes.
Yes, most of these websites state that any funds received via donors on the Internet have a tax on them. However, it is very unclear as to what kinds of taxes, and what to do about it. Congress and the IRS have not addressed crowdfunding income specifically, which means there isn’t a great guideline for what to do about all this mess. However, you and your CPA, are still responsible for figuring this out before April 15th each year.
Are you ready?
Fortunately, we have done the research for you. Hence, before you go into a Go-fund-me panic, please read the following so you may be aware of the steps that need to be taken before you are turned upside down by the IRS:
1. Figuring Out Your Crowdfund
The first thing’s first is figuring out what style of crowdfunding you are dealing with.
Every means fall into three distinct categories and those are:
- Reward-Based: usually for creative enterprises or personal fundraising
- Donation-Based: rather, self-explanatory; you receive donations for a cause.
- Equity-Based: typically used for raising capital for businesses and companies.
Reward and Donation based services use third party payment processing for money collection typically via PayPal or Amazon Payments. Each of these services have different rules as far as collection goes, but both work for the IRS, which means that you can expect taxes that need to be paid for whatever funds are received. If you have raised over $20,000 and have 200 transactions throughout the year, you will receive a Form 1099-K (Payment Card and Third Party Network Transactions) report.
Donation-based crowdfunding is likely to be considered nontaxable gifts. However, for Reward Based, you may have to carry out income tax ramifications. Click," Tax Clinic: Crowdfunding Contributions and State Sales and Use Taxes” The Tax Adviser, to see more helpful information.
2. The Income Taxes Ramifications
Funds received by means of a reward-based crowdfunding are most likely taxable income according to section 61 of the Tax Adviser. Therefore, all means need to be reported by the creator at the end of the fiscal year. However, some deductibles may be given depending on several factors. These factors may include:
If Your Crowdfunding activity is for Trade, Business, or Hobby purposes:
- If the activity is deemed a trade or business, all expenses that cater to the trade or business should be deductible. (Section 62)
- If the activity is deemed a hobby, only expenses to the extent of the income are deductible. (Section 183)
- Whether the activity is trade, business, or hobby, it is still a facts-and-circumstances determination, meaning there is a “trial” to see which of these you are and what deductions may apply to your specific crowdfunding needs. For more information on what you may apply for, check out Tax Practice Corner's "Business or Hobby? The Nine Factors article for their advice on factors and applications.
If Your activity is deemed a Startup Business:
- There may be a startup or organizational cost involved, and if so, a taxpayer must capitalize these costs unless the payer makes an election under section 195, section 248, or section 709.
- Section 195 applies to startup costs.
- Section 248 applies for corporations, and section 709 applies for partnerships dealing with organizational costs.
- The deduction is taken in the year the trade or business becomes active or the year the partnership or corporation begins business, and the remainder of the startup costs are amortized over a 15-year period beginning in the month in which trade or business becomes active or the partnership brings business.
- The taxpayer is deemed to make these elections to deduct and amortize in the year the business activity begins.
- For fees to be deducted at all (startup or organizational) the activity must be considered an active business.
The Type of Accounting is used by the Crowdfund Creator:
- Many websites, like Kickstarter and IndieGoGo, warn the patrons that the websites do not guarantee that the projects mentioned will be completed. Therefore, it is entirely possible that funds received by the creator can be used for other means not mentioned online. It is under their absolute control. Based on the “claim-of-right” doctrine, this income is taxable regardless of the accounting method.
- Cash flow problems may occur if there is a timing issue where the income tax applies to one year but the related expenses are not deductible until the following year. If so, the creator can plan to end their online campaigns early to avoid penalty of carrying over two years.
The Value or Type of Reward is given by the Backers and Patrons:
- This applies to backers who receive something of value in exchange for contribution to the funds.
- If the value of the reward offered cannot be determined, or if the reward value is less than the pledge amount, additional evaluation may need to be required to determine if any part of the contribution can be deemed a non-taxable gift.
- Section 102 allows for nontaxable gifts, which means that it is given by generosity of a patron and cannot be taxed since it is detached. For this to be so, gift treatment would have to be equal or greater than the contribution. Contributions from backers who choose to forgo the gift may also be considered nontaxable.
3. Further Uncertainty
As mentioned above, even though crowdfunding is becoming more common and popular, the guidance for tax support is still unclear for creators and patrons. In summary, the treatment of funds generated through crowdfunding means depending on the method of fundraising and value of the reward offered, if any. Once these are established, it is necessary to find out if your means are for trade, business, or hobby purposes. Those ramifications will apply depending on which category you fall into.
If you need a representative to help guide you with your crowdfund taxes, please contact us at Basis 365. They are leading experts in accounting and online bookkeeping and would love to hear from you for your crowdfunding resources. Together, they can figure out the best plan in order for you to receive as many benefits as possible. Contact them online through their Contact Sheet or call us anytime at (855) 236-5669 x711.
** Special thanks to Cheryl T. Metrejean and Britton A. McKay of the Journal of Accountancy for providing us with this helpful information**