For many startups, getting cash in the door to get your startup going can be challenging. However, crowdfunding companies like Kickstarter and Indiegogo have made raising cash for your startup or idea fairly easy. You post your idea on their site, get people to contribute small amounts of money, and hopefully raise enough cash to “kick start” your idea or startup. What many people neglect to take into account is that the money you receive from your crowdfunding campaign is considered income and thus you are required to pay taxes on that income.
Before I go any further, the crowdfunding campaigns I am talking about are campaigns in which money is being crowdfunding for a particular product, project, or business related goal. Money raised through these vehicles for medical expenses or for some other personal need is generally considered a gift and is not taxable to the recipient. However, if the site you used issues you a 1099K or other tax document, you need to account for that and explain it in your tax return. Even though you would not pay tax on those funds, the IRS receives that same tax form as well and does not know that the reason behind that tax document is a gift, not a business endeavor, and will generally send you a letter saying you owe back taxes. Also, in any case you are unsure of your particular tax situation, consult with a CPA. Everyone’s facts and circumstances are different.
So why are funds raised through Kickstarter or Indiegogo considered income? Money raised through these crowdfunding sites cannot be considered equity or debt. Those who are supporting you in your campaign do not have ownership over your product or company or idea and they are not going to be repaid back after a certain amount of time. The funds that you raise in your campaign are yours to use in creating the product or idea that the campaign was for and in exchange your backers are receiving some sort of item or services for their contribution. This is effectively a business transaction selling goods or services between two willing and able parties. Thus the money you received must be considered income. And since it is income, it is taxable.
However, there is good news! Whether you intended to do so or not, you have created a business! Even if your idea was just to make potato salad, you have created a business to do so. That means that expenses that you incur that are reasonable and ordinary in the course of creating, making or delivering your product or idea are deductible and will offset the income that you raised from your campaign. If you haven’t created a legal corporation, partnership, or multi-member LLC, your business you created is considered a sole proprietorship and the income and expenses from this endeavor would be recorded on Schedule C of your 1040 tax return.
It is important that if you are going to start a business through a crowdfunding campaign (or any business for that matter), you should have some good accounting software that can keep track of your income and expenses so that come tax time, you have all the information you need to correctly claim income and expenses on your tax return. If you don’t do this, you can easily miss expenses or income when you are preparing your tax return, which can be very costly.
Crowdfunding on Kickstarter or Indiegogo is a great way for startups to get funding for their idea or product, but they need to take into consideration that the money they receive through their project is considered income and that it is taxable.