Crowdfunding Your New Business? Tax Impacts of Three Appeal Methods

Do you intend to boost capital for your new business through crowdfunding? This modern source of investors and contributors can be a lifesaver for many small businesses and new ventures. But it also may complicate your tax situation. How does crowdfunding affect taxation? Here are a few things you need to know about the three main incentive structures you may use. 

1. Equity Crowdfunding May Not Be Taxable

When many new businesses need to raise capital, they seek outside investors. Crowdfunding can be used to accomplish this, albeit from much smaller individual amounts. The good news for both you and the investors is that investments in a company usually aren't taxable income when made. The person gets equity, or a piece of financial ownership, in the company.

Taxation, though, may occur when the person sells their investment. This may result in capital gains taxes or losses that can offset other sources of income or other years.  

2. Contributions May Not Be Taxable

Not all businesses crowdfund to make a profit. If your business is structured as a nonprofit enterprise or charitable institution, money given through crowdfunding may be considered charitable donations. Donations to qualifying organizations are generally not considered taxable income to it and may be deductible by the giver. 

You should ensure your organization qualifies for charitable or nonprofit status before starting the campaign. And if you plan to offer some type of incentive, you may need to differentiate between the value of these incentives and money given without expectations in return. 

3. Incentive Reward Funding May Be Taxable

Most crowdfunding campaigns offer something in return for a person's contribution. If it's not equity in the company, it is often some type of prize or some of the products you plan to make with the money. In this case, the IRS is likely to classify income earned through the campaign as taxable income.

The news isn't all bad. If you offer a reward — even just promotional swag — you can deduct these expenses from the income they generated. And if the offer includes products in return, you have two future tax benefits. First, you can deduct production costs to offset the crowdfunded income. Second, you may be able to report that sales income in early years when you aren't generating a taxable profit yet. 

Where to Learn More

Crowdfunding and taxation can be a complex subject. Before you decide on your campaign and methods of attracting funds, meet with tax services like Guaranty Tax & Insurance in your state. Tax specialists can work with you to find the best way to minimize taxes for you and those who might fund your work. Then you can move forward with your business plans in confidence.