Crowdfunding is still a relatively new concept, but as more people use crowdfunding as a source to raise funds for their various businesses or projects, it becomes increasingly crucial to understand the tax implications of its use.
What Is Crowdfunding?
Crowdfunding is when an individual, an organization or a company raises funds for the production of an idea, a service or a product. Strangers, family members and friends may donate to the crowdfunding project online and are generally (but not always) promised something related to the idea in return.
The donation can vary to any amount; most of the time, the individual amounts gathered through crowdfunding are quite small. The uniqueness of crowdfunding is the mass online audience that is made available to you. Therein lays the genius of crowdfunding: even small donations can lead to large funding when you reach a large amount of donors. There have been a wide range of crowdfunding projects, such as supporting new books, production of movies or unique bottle openers. Some people may use crowdfunding to raise funds for their college education.
Types of Crowdfunding
There are essentially four kinds of crowdfunding methods. The altruist method allows people to simply donate money and not expect anything in return, as the project is for a better cause; this method is generally used for charitable fundraising purposes. The lending method allows people who donate to receive interest back on a loan. The equity method allows donors to have a vested interest in the newly formed company or organization that they support through crowdfunding. The gift method allows donors to receive something tangible in return for their contribution. This last method is increasingly popular, answering the supply and demand economy in today’s world.
Crowdfunding Tax Implications
Tax guidance regarding crowdfunding has been somewhat vague. The main cause for the ambiguity is the many forms, methods and factors attributed to the crowdfunding venture. The income derived from crowdfunding is most commonly considered business income to be declared on your tax return. It can also be treated as a capital contribution, a loan, a gift or a combination of any of these.
You are able to deduct certain expenses as long as they are related to the production and delivery of your project. For example, assume that you decide to crowdfund for an animated movie production project. You have the transcript available and promise to give each donor a copy of the finished movie on DVD. The DVD is sold for $20 but costs $10 to make. The income you raise is considered business income. The cost of the DVD is considered an allowable expense to deduct on your tax return. There is a grey area regarding how much of the costs related to the production of the movie you can deduct. Essentially, all costs directly related to the production of the movie should be deductible against the crowdfunding income.