Crowdfunding is a way for businesses to obtain capital from multiple sources. It has become more prominent with the development of websites such as Kickstarter or Idiegogo. One common misconception about crowdfunding is that only start-ups use it, but it can be an effective way to acquire funding for established businesses too. It can also be a great way to “test the market” with a new product. For example, if a company wants to develop a new product they can put it on a crowdfunding website and they will instantly see if there is a demand for the product based on how many people decide to fund the project. However, businesses using crowdfunding need to be careful because in some cases crowdfunding may result in taxable income.
There are three main types of crowdfunding, but as crowdfunding continues to evolve many more types of funding will develop.
- Reward-based crowdfunding – is a type of funding where companies offer funders a product, experience, or some other type of perk. This is the most common type of crowdfunding and can be used by businesses and individuals. It is usually established to fund a project. These types of projects can vary from a musical act that wants to record an album to an apparatus that is a “better” way to extract honey from a bee hive.
- Equity crowdfunding – companies are able to sell their securities to a large number of investors. Prior to March of 2015, only accredited investors using special portals could buy the securities, but now there are different tiers that allow companies to sell securities to a wider range of investors. There are no limits on how much an individual can invest in a Tier 1 company. Individuals can invest up to 10% of the greater of their annual income or net worth in Tier 2 companies. Tier 1 companies’ financial statements must be reviewed by an accountant and Tier 2 companies’ financial statements must be audited.
- Donation-based crowdfunding – allows individuals, groups, and not-for-profit organizations to raise funds for almost any charitable cause. Usually and funds generated from donation-based crowdfunding are considered gifts and therefore not taxable to the campaign creator.
The reward-based crowdfunding may be taxable. If the value of the reward can be determined then the funding is taxable. It is basically like you are selling the reward to the funder and you will have to recognize the funding as income. If the funding is determined to be taxable income then the business also has the ability to deduct expenses associated with generating the funding. However, if the value of the reward cannot be determined or the reward does not have any value then the funding would be a non-taxable gift.
Crowdfunding has become a much easier option for a business to obtain capital. In the past businesses had to go door to door to try and find funding and they may talk to 100 people to get the necessary funding. Now with web-based crowdfunding, a business can use the internet to obtain the same amount of money in much less time and effort.
If you have any questions about Crowdfunding or any other questions feel free to contact me.
Will Stevens, CPA
Work Phone: (803) 799-0555 ext. 38
Cell Phone (803) 960-5075