This article was written by Amy Feldman in NEW YORK (Reuters) – August 11, 2012, reprinted by permission
When Julie Uhrman, chief executive of gaming start-up Ouya Inc, went looking for funding to launch a new video gaming console, she turned to crowdfunding site Kickstarter Inc.
The goal: $950,000. Instead, when the campaign ended August 8, so many gamers and game developers had pledged $99 (or more) to get the new Android-based Ouya that the company raised $8.6 million, making it one of the biggest crowdfunding success stories ever.
"We've been in the public consciousness for only 30 days, and we sold over 60,000 boxes," Uhrman says. "There's a good audience (on Kickstarter) for the product we're trying to build, and it allowed us to move very quickly."
But one important thing has been overlooked: taxes.
"We've been talking about that, but we have been so busy," she says. "Luckily, we have good accountants, so they'll sort it out for us."
Crowdfunding on sites like Kickstarter or Indiegogo Inc is a relatively new way to raise funds. It allows an entrepreneur to get proceeds for a specific project, often offering "rewards" to those who pledge.
When Kickstarter began in 2009, crowdfunding was largely used by musicians, film makers and other creative types to raise small sums of money for projects that might not make any money. But as it's grown — in some cases, becoming an alternative to venture capital — the dollars involved have gotten bigger.
Ouya is one of eight campaigns to raise at least $1 million on Kickstarter. All told, Kickstarter backers have pledged more than $300 million since its launch, while competitors like Indiegogo have also grown rapidly.
"Crowdsourcing is becoming a popular way for start-ups to raise cash, and the companies that receive the cash may not realize the proceeds are taxable," says Murray Solomon, a tax partner at accounting firm EisnerAmper. "They may get a very unpleasant surprise when they build all their prototypes and spend all the money."
In fact, if you raise more than $20,000 on Kickstarter from more than 200 people, you'll get a Form 1099-K (a new tax form introduced in 2011 and required for third-party payments above that threshold), courtesy of Amazon Payments, which processes transactions for the site.
Indiegogo, which allows pledges by PayPal or credit card, notes in its agreement that users "shall have full responsibility for applicable taxes" on their projects' funding. (Kickstarter and Indiegogo both declined to discuss tax issues.)
NEED TO KNOW
If you're planning to crowdfund, here's what you need to know:
If it's a sale, it's taxable.
Say, for example, a startup uses a crowdfunding site to raise money to develop a new iPhone accessory, and offers "rewards" — as these campaigns typically do — of those accessories in various combinations for different pledged amounts.
"That's the most common situation, and it's taxable because you get something in return," says EisnerAmper's Solomon.
Even funds below the 1099-K reporting threshold remain taxable, says Solomon.
This spring, Pizza Delicious, a New York-style pizza place in New Orleans, raised $18,300 on Kickstarter for a new pizza oven, offering pizzas, bumper stickers and T-shirts to those who pledged.
"We thought it would be a cool way to get people excited and drum up support for projects," says co-owner Greg Augarten. "It's taxed like any other income, but it's still worth it."
Just because the funds are taxable, though, doesn't mean you'll actually owe tax on them. If your business expenses are higher than the money you bring in, you may not owe anything.
Michael Guenther, a certified public accountant in Sacramento, who works with video game companies and has three Kickstarter clients, says most such startups would not owe tax in the first year because of the combination of business costs and tax benefits, such as the research and development tax credit.
"Most Kickstarter companies would use nearly 100 percent of their Kickstarter funds to build whatever it is they're looking to build," he says.
That's generally the case for musicians and other creative types raising small sums for specific projects.
Ken Thomson, a Brooklyn-based composer and saxophonist, raised $2,665 last December for a new album. Most of his 89 backers paid $25 and will get the CD when it's done.
"It casts a wider net, and we were able to get more pre-orders," Thomson says.
But the idea that he'll owe taxes after spending at least $10,000 to produce the CD makes Thomson laugh. He figures he won't owe taxes since he expects his expenses to dwarf the money he raised.
"I dumped the entire amount of money I got from Kickstarter into the studio, and then I have to figure out how to give everyone CDs," he says. "When you make a record, you assume you are going to lose money on it."
There are situations in which crowdfunded pledges may not be taxable. Some may be considered gifts, others donations. Once the JOBS Act, which allows startups to solicit investors online as a way to encourage funding of small businesses, takes effect, some contributions may be considered "capital contributions," and not taxable when they're received.
In general, a gift is a contribution in which the giver gets nothing in return. Gifts are not taxable to the recipient, and gift givers are allowed $13,000 a year per recipient tax-free. A recent do-gooder campaign on Indiegogo raised more than $700,000 for a bullied school bus monitor to take a vacation.
"That's the perfect example of what would be a gift," EisnerAmper's Solomon says.
Charitable donations, to a registered 501c3, are another exception. Donations may be both tax-free to the non-profit and tax-deductible to the donor.
With crowdfunding still a niche business, accountants are puzzling over the lines between different tax situations. As EisnerAmper's Solomon puts it: "I think it's so new that there are going to be some gray areas."
(This story in 8th paragraph, corrects description of eight $1 million-plus efforts to campaigns, because they were not all start-ups.)