We all love new things and Crowdfunding or Crowd Financing certainly sounds new but is it? What about taxes? Rumor has it that it’s tax free! Stop or at least slow down and gather the facts before you run out and get yourself in over your head.
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Crowdfunding is a new word for a very old business practice, called raising money. Unlike venture capital an equity stake (share of ownership) is not part of the equation. Websites like Kickstarter.com came into existence as a means for creative projects such as short films, literature and art to get funded.
Evolution of a Good Idea
The novel approach of crowdfunding for artistic projects allowed for a much wider range of potential creative patrons to participate in the process of helping creative endeavors get off the ground. It enabled new and less known artists who lacked access to wealthy benefactors, both corporate and individuals, to solicit funds to start and complete creative projects.
Thanks to the great equalizer that the internet can be, underfunded artists were able to turn to crowd funding sites and raise money in small increments from large numbers of people rather than the traditional method of finding one, two or a small handful of large donors. Crowdfunding quickly expanded beyond traditional artistic projects into areas like video game development. While these have an art component they are really for profit businesses.
The Root of Confusion
When a for profit business receives money from investors it is generally not taxable provided that the business is offering something tangible in return such as an ownership stake, stock or the promise of a return of some sort on their investment. There are very specific legal requirements that a business must meet in order to enter into these types of arrangements that go well beyond what can be signed up for on a website.
Disclosures and a slew of other paperwork is required by a variety of federal and state agencies before a business can raise capital that are not required of individuals and organizations receiving funds from crowdfunding sites. The bottom line is that simply because you are asking for and receiving money to grow a business is not the same under all circumstances.
When an individual or business receives money even if the person providing the money believes it to be an investment, it is income for the business and is taxable as income. There is a mistaken belief that if a gift such as tee shirt or coffee mug is given in return for the money, the funds are not taxable. As far as the IRS and many states are concerned this is a sale and may not only be subject to income tax but sales tax!
On the other side of the coin many believe that if nothing changes hands at the time money is given but a promise of a future benefit like a discount or early access to a product or service, that the funds are exempt from being treated as income. Once again, as far as the IRS is concerned it’s income and taxable as such.
Yet another version of this myth is that if nothing is offered in return for the funds, then it is not considered a sale and therefore not taxable. This is also incorrect. The final version of the misconception is that there is a threshold that must be crossed for the amount of money to be considered income.
The IRS considers all money, from the first dollar to be income and income tax rules apply. This is the point where a CPA steps in and explains that income can be offset by expenses to reduce or eliminate any taxable liability, but I am not a CPA let alone your CPA, so I strongly suggest you consult with one before making any further assumptions.
Photo Credit: Commodity Trader