Have you ever considered using an unorthodox method of financing known as crowdfunding? Crowdfunding has become a popular way of receiving financial support for business ventures via large groups of people. While crowdfunding might seem like free money, it definitely does come with tax implications. Read the rest of this article to learn how the use of crowdfunding will impact your business!
What is Crowdfunding?
If you’ve never heard of crowdfunding before, it is an effective way of raising significant amounts of money to complete a business project. Most crowdfunding is done online, offering the most access and opportunities for people to contribute.
Crowdfunding is designed in a way that allows each person to contribute with each contribution actually being meaningful. Because so many people have the ability to help crowdfund, it makes even smaller donations all the more meaningful when hundreds or even thousands of people are making that same donation.
When you’re required to directly ask people for money face to face, it makes each person you interact with important to helping your overall effort. When someone is unable to donate a significant amount, it can make them feel uncomfortable donating.
Crowdfunding on the other hand, allows for plenty of privacy and comfort. People have the ability to anonymously contribute, which will make them more likely to help even with smaller amounts of money.
With thousands of people contributing here and there, you’ll slowly but surely reach the financial goals you’re aiming for (if you’ve got a good project worth funding)!
Crowdfunding a Struggling Business
Crowdfunding is a fantastic way of allowing you to engage in projects you otherwise would be financially strapped by. This does make it sound like free money, but the catch here is that not everyone can benefit from crowdfunding.
The biggest tradeoff with crowdfunding is that your business project needs to offer a value worthy of being funded. As the manager of a crowdfunding campaign, you have the ability to present and market your project as you see fit.
While crowdfunding can serve as a good source of external funding, that doesn’t always mean that it will pan out. Just like how you need to attract customers to your business, you’ll also need to attract donors to your crowdfunding efforts.
If nobody is aware of your crowdfunding campaign, then they won’t know to donate. Furthermore, there needs to be a good reason for crowdfunding your business. Usually this comes down to two things; either customers want a specific product you’ll make as a result of crowdfunding, or they want to keep you offering an existing product for sale.
With those two leading concepts, you might be wondering whether or not crowdfunding can help a failing business. For simplicity’s sake, you can, but only under the right set of circumstances. Crowdfunding absolutely can help revive a business, but most campaigns end up flopping because business owners aren’t adequately prepared for what a crowdfunding campaign requires.
Anyone considering using crowdfunding as a source of external funding should know that it is called a campaign for a good reason. Campaigns are an ongoing, organized effort towards a goal. By definition, a crowdfunding campaign entails continuous effort to draw attention. Not only do you need to grab people’s attention, but you also need to give them a good reason to donate.
Offering rewards and incentives once your project is funded is a great way of offering value without sacrificing anything upfront.
Tax Implications of Crowdfunding
Although you don’t need to sacrifice anything other than your time and effort to earn money through crowdfunding, it isn’t entirely free. Depending on how you’ve designed your crowdfunding campaign, donations you receive will be treated differently.
For business purposes, almost all crowdfunding efforts will not count as charitable donations. The end result of any business crowdfunding usually ends in a profitable endeavor for donors or the business owner. This makes the nature of the donation not charitable.
Some money from crowdfunding can be classified as a gift if you don’t offer anything in exchange for the donation. This means that any promise of a future discount, product, or any other benefit will void it from being a gift.
That means that most crowdfunding will be classified as taxable income and treated as such. Each donation you receive is treated as a transaction. If you receive more than 200 donations or $20,000 (whichever comes first), you’ll receive a form 1099-K. The tax rate you’ll face for this income depends on the tax bracket you fall into which is determined by total income.
In addition to being taxed like regular income, in some states you’ll also incur an additional fee for sales tax. This varies due to different rules and regulations across states, so you’ll need to check the laws in your state. If you do need to collect sales tax, this makes crowdfunding even costlier come tax season.
Professional Advice on Crowdfunding
While crowdfunding might seem like a glamorous and easy way to dig your business out of a financial hole, there’s much more effort required to making a campaign successful. Hours of careful planning, research, and continuous outreach are all key components of a crowdfunding campaign.
If you’re familiar with a marketing campaign, then you’ll understand the theory behind a crowdfunding campaign. If nobody knows that your business needs help funding, then they won’t even think to help you in the first place. This is why you need to place your campaign in front of as many people as possible.
Most campaigns also offer some form of incentive to help entice donors. Doing this is likely to make the effort more successful, but it also carries a critical tax implication. When donations are made without any expected return, they can be treated as a gift.
Most crowdfunding donations do come with some sort of quid pro quo, which makes them a business transaction. This will make any crowdfunding donations you receive taxable income.
To fully understand the ramifications of using crowdfunding as a source of external financing, get in touch with the accountants at Evergreen CPAs! While crowdfunding might seem like a great solution to your problems, it might not yield the return you’re looking for. The experts at Evergreen CPAs can analyze your business situation to help you decide how best to proceed! Talk to Evergreen CPAs before you think about crowdfunding!