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posted Sep 23, 2013, 9:15 AM by Unknown user   [ updated Sep 23, 2013, 9:21 AM ]
Editor's Note: Richard Streitfeld (CPA, CFE) writes in with some tax tips for crowdfunders as the IRS struggles to keep up with the rapidly evolving business ecosystem.

Banks (still) aren’t lending, the government is broke (or broken), and venture capital is highly competitive — so how should one start a business in 2013? Crowdfunding says, “Ask my friends (and their friends).” It goes against everything we are taught to believe in a hyper-capitalist society: we give only when there is a return, a dividend, a tax break, a stake in the growth. 

Enter crowdfunding. KickstarterIndiegogoRocketHub and others are proving the above notion wrong in a big way. While by no means a sure-fire method to raise funds for a business venture, crowdfunding has countless success stories, some of them in the millions of dollars. Taxes are the last thing the founders are thinking about while they are consumed with starting the business and pitching it for crowdfunding — until April rolls around.

Funny thing, the IRS and state taxing authorities haven’t been thinking about it much either (yet). It’s hard for institutions to keep up with rapid change. Make no mistake: crowdfunding is a radical departure from traditional business financing. No wonder backers and businesses are left without much guidance once their business has received crowdsourced funds. Here are some points to consider:


You are a business. Yes, you love what you do. Yes, you may not make a profit at first. But in most cases, your aim is sales of a product or service, your backers are receiving something in return, and you must refund the monies if you do not reach your goal and provide the promised reward. Tax consequences follow from these premises (there may be an exception if the company seeking funds is a non-profit).


Businesses can choose either “cash-basis” or “accrual” accounting. Cash basis is easier, and also means your taxes are based on that $50,000 you received — even if work has not begun. Accrual may be more beneficial, and is also more complex. This is an important decision that you need to make your first year “in business” (see above).


Depending on your structure, you may well be subject to self-employment tax as well as income tax on any earnings — that is, income less expense. This can be a killer! If you are the default “sole proprietor,” then expect to pay nearly 15 percent additional. There are alternatives, but think through the implications with a professional before you start soliciting.


Does your state or city charge sales taxes on products or services? Depending on the jurisdiction and what they tax, you may be required to charge and file — at least for in-state purchases. This is an added cost to the customer or to you (if you want to absorb the cost to stay competitive). Sales taxes are often the “low-hanging fruit” for revenue-strapped states, and some of them have already put crowdfunders on notice.


Some professionals are asserting that you can exclude from sales tax or income tax part of the money received if you set a base market value. Let’s say you are raising funds for a CD, and you would sell it for $30. You receive $100 from a backer — could $70 be excluded from the calculation? Gifts are supposed to be made out of “detached and disinterested generosity,” but crowdfunders often offer increasingly valuable gifts as the level of sponsorship rises. Tread very carefully here until clear guidance is available.


Make sure your tax preparer is familiar with credits for “research and development” and “domestic production.” These may be very helpful for you to limit your tax liability.


Recent federal legislation will allow crowdfunding to be offered more along the lines of a traditional security, with investors able to take ownership interests. The Securities and Exchange Commission has yet to issue guidelines, however, so “equity crowdfunding” has been slow to launch (and may not be suitable for many smaller enterprises).

No matter what you decide, just remember that you have not received a windfall that is somehow exempt from the normal business rules. In most cases, your new venture is not just a hobby, but a crowdfunded business.

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