Crowd funding, through sites like Kickstarter, can seem like the easiest way to find money for unusual projects — like building two 10-story tall Tesla coils — as well as for more common projects that are just hard to finance, like recording an album. The approach is certainly appealing: you can ask all sorts of people to provide money for a cool idea. But since money does enter into the matter, that means we have to start talking about accounting and other issues.
New Funding Model, Old Problems
There’s a certain sense that crowd funding is a new solution to the problem of how to finance creative projects. But, it faces some old problems of its’ own. Because most of the organizations and individuals signing up for Kickstarter, IndieGoGo and similar sites are not non-profits, the IRS expects to get a fair share of any money raised. Just because there’s a cool project involved doesn’t mean that the IRS is going to ignore the fact that money is changing hands.
So far, there hasn’t been anything that could really be called a test case, where the IRS has codified how money raised through crowd funding should be handled. But the IRS defines income as taxable, no matter what source it comes from. It’s tempting to argue that many crowd funded projects run a thin margin: the organizers pull together just enough funds to complete the project and send out rewards to their funders. But just because a business doesn’t actually make money doesn’t mean that it isn’t a business, at least in the IRS’ view.
That means that as you’re putting together your budget for a project, before you decide how much to ask for, you need to calculate how much you’re going to have to pay in taxes on the amount you raise. It’s best to speak with a tax professional about your plans, though many accountants and other tax professionals simply haven’t handled enough of these situations yet to be able to give you a standardized answer. They’ll probably need to sit down and do some numbers themselves.
There is an alternative to the tax headache that you may be facing: establishing a 501(c)(3) to operate the project. It needs to be in place before you ever start putting together your funding, because all money from Kickstarter or any other platform you might use has to go straight to the non-profit. It can’t even pass through your checking account, unless you enjoy awkward conversations with the IRS.
But setting up a non-profit organization is not something to take on lightly. There’s a mountain of paperwork that goes along with establishing a tax-exempt status. It may be cheaper, both in terms of your time and money, to just pay your taxes and keep moving.
A Project is a Business, Even for the Short-Term
The average Kickstarter project is for less than $10,000. That doesn’t sound like a lot, especially when you’re thinking about taxes and running a business. But even if you’re only running your project for the short-term and don’t have any plans for following up on it, you’re still running a business. You’re creating a product (sometimes multiple products, depending on what incentives you offer to contributors) and you have to operate as a business.
That comes with some downsides: you do need to invest the time in properly keeping records for your project, down to collecting receipts for even small amounts. It’s not entirely out of the question that you could face an audit in the same year as you conduct a Kickstarter project. After all, the IRS makes a point of auditing tax payers who seem to have something out of the ordinary going on in their bank accounts — a really successful project dumping $30,000 into your bank account that you didn’t have before definitely is out of the ordinary for most of us.
But there are also upsides to making sure that you meet all the requirements of operating as a business: the cost of all those incentives that you offer to your funders are a necessary cost of doing business. Those expenses can be deducted on your taxes. The reality is that you may not wind up owing all that much in taxes for a successfully crowd funded project, provided you take everything into account early on. That’s necessary for such projects anyway. There have already been some cases were crowd funded projects turned out to be losing propositions, simply because the organizers didn’t take into account the full cost of the incentives they offered, on top of adequately budgeting for their projects.
Do Your Research
As the crowd funding model evolves, we’re going to see financial questions that haven’t even come up yet. Many states continue to struggle with the question of charging sales tax on online purchases. It’s a question that will have a huge impact on the way that rewards or incentives for funders work: despite the terminology, Kickstarter’s platform is essentially based on project organizers selling products to funders at a high margin and then using the proceeds to complete a project. Under most sales tax laws, rewards or incentives should be subject to sales tax.
There are other laws at work here, too: depending on just what type of project you’re funding — or if you really do intend to turn your project into a long-term business — you may have certain accounting obligations. Crowd funding has already faced some legal issues regarding how it falls in the spectrum of investing activities. Before it can be considered a perfectly mainstream way to fund a project, there will be some battles fought. You can avoid being a test case by making sure that you’re covering all your bases in terms of issues like accounting and taxes.