Crowdfunding continues to be a popular way of raising money, but you need to stop and think before you jump on the bandwagon. As with other transactions, the IRS wants its piece of the pie, and you need to make sure you understand the tax rules to avoid an April surprise.
Three Types of Crowdfunding
There are three general categories of crowdfunding. Which category your fundraising falls into determines if and how it will be taxed.
Reward crowdfunding is the most popular type of business crowdfunding. In exchange for their contributions, contributors receive an early version of the product, a gift certificate, or something else of value.
The fact that contributors get something rather than just giving a no-strings-attached gift turns the transaction into a sale. It’s no different than if you rung someone up at your cash register or took an order through a traditional ecommerce site.
The money you receive from reward crowdfunding is taxable income subject to income tax. Depending on your state, you may also need to collect sales tax on the sale.
Donation crowdfunding is used more on the personal level such as to raise money for hospital bills. If the money is given as a gift with nothing in return, it is treated as a gift for tax purposes.
Gifts are not taxable income except in large amounts subject to the gift tax rules. Since crowdfunding is usually characterized by small contributions, gift tax would almost never apply.
Equity crowdfunding is a newer form of crowdfunding that lets you sell stock in your company without doing an IPO on a big stock exchange. Like other stock sales, the contributed capital is not taxable income.
However, equity crowdfunding is tightly regulated, so you do need to make sure you’re in full compliance with SEC regulations.
The good news is that you may not have to pay tax on every dollar of crowdfunding money. Like other business income, you can subtract your ordinary and necessary business expenses.
For example, if you offer a product that costs you $10 for a $50 contribution, you only pay income tax on $40 not $50.
The one problem you might face is when your crowdfunding campaign stretches across multiple tax years. If you’re raising money for a pre-production product at the end of 2018 and don’t pay any money towards producing the product in 2019, you could end up paying taxes on all the money you raised in 2018 without being able to take a deduction until 2019. That could mean a higher tax rate in 2018.
Crowdfunding Income Tax Mechanics
When you raise money through a crowdfunding platform, you’ll usually get a Form 1099-K from the platform at the end of the tax year. This form will detail the money you raised along with any transaction processing fees that you paid.
Regardless of whether you receive a 1099-K or not, you need to include your taxable crowdfunding income on your personal Schedule C or your business tax return. You would then be able to claim your expenses subject to the usual rules of being for business purposes and keeping adequate documentation. Your normal income tax rate will apply to your next profit.
To get help preparing a crowdfunding tax return or tracking your crowdfunding income and expenses, talk to Honest Buck Accounting today.