The Crowdfunding movement has moved from an internet e-commerce buzz word to an actual viable way for everyone from the smallest of artists to high profile actors to get funding for a project that otherwise wouldn’t happen.  (For example $5.7 million to make a Veronica Mars movie   The concept is simple: creators pitch a product to the public, and whoever likes the product pools together funds to support the creator.

Crowdfunding websites have proliferated over the last decade, starting with ArtistShare (2001) and followed later by sites such as EquityNet (2005), Pledgie (2006), Sellaband (2006), IndieGoGo (2008), GiveForward (2008), Kickstarter (2009), RocketHub (2009), Fundly (2009), GoFundMe (2010), Appsplit (2010), Microventures (2010), and Fundageek (2011). These websites helped companies and individuals worldwide raise $1.47 billion in 2011 and $2.66 billion in 2012 (from which $1.6 billion was raised in North America). In 2012 there were more than 1 million individual campaigns globally.

To many, a crowdfunding project through a website like Kickstarter might seem like an uncomplicated way to bring their dream to reality.  But, unfortunately, Uncle Sam, Kickstarter, and your state taxing authority won’t let you take the entirety of the money your project was funded without getting their share. I’m going to run down how $50,000 from a funded project to create a new board game would be spent.

For this example, your benefit levels are $5 – No benefits other than “thank you” acknowledgements and $30 for one copy of the board game.  You state that the board game will be sold for $50 when it hopefully starts getting produced at a larger scale after the kickstarter.

 Gross Project Funds Raised:  $50,000 ($8,000 at the $5 level, $42,000 from 1,400 board game orders)

 1.      Kickstarter and Credit Card Processing Fees (9%):  Kickstarter takes a 5% fee off the top, and (which processes the credit card payments) takes 3-5%.  We’ll split the difference and call it 4% for credit card fees for a total of 9%.

  2.     Cost of Goods Sold – Content Costs (42%):  This is the actual cost to produce whatever funding benefits you are giving to the backers.  Let’s say once you factor in all other costs to produce, these cost about $15 a game ($21,000 total).

 3.     Sales Tax (3.5%):   We’ll do this scenario in Texas.  You produce the board games in Texas and make exactly half of your sales to Texas residents.  You will need to register for a sales tax permit and collect sales tax on all sales to Texas residents (but not the out of state residents).  If you did not collect the tax on the pledge in addition to the $30 (or state that sales tax is included), you will owe tax on the full $30.  (700 * $30 * 0.0825=$1732.50)

  4.     Personal Income Tax (11.2%):  If you did not create a legal entity for the kickstarter project, all of the income and expenses from this project will be reported as a Schedule C business on your individual tax return.  The first question is, how much of the $50,000 should be considered gross income.  It is clear that the $42,000 for the board games, should be gross income. Backers received a project for less than the fair market value so there is no gift.  “Where consideration in the form of substantial privileges or benefits is received in connection with payments by patrons of fund-raising activities, there is a presumption that the payments are not gifts.”  Rev. Rul. 86-63.  However you may be able to argue that the $8,000 from the backers who received nothing was a gift.  A gift is a transfer that (1) is voluntary, and (2) is motivated by a “detached and disinterested generosity.”   Commissioner v. Duberstein, 363 U.S. 278, 285 (1960).

 You will be able to deduct the Kickstarter and credit card processing fees, content costs, and the sales tax from your gross income of $42,000.  This would leave you with a net income of about $15,000.  The surprising thing is how high the tax rate is on this remaining amount.  You will owe self-employment tax (15.3%) on the net income amount, as well as your ordinary income tax rate on the amount (less a deduction for half of the self employment tax you paid).  For a person in the 25% tax bracket, this would be about $5,600 in self employment and income taxes.  If you live in a state with state income tax, this percentage will be even higher

 What’s Left? About $17,000 – 34% of the Original Amount.

 The thing we haven’t accounted for is how much of your time you put into this.  For those artists whose project is truly a labor of love, the bottom line won’t matter as much. But for artists that work on a project like a full time job and need the bottom line to pay bills, what’s left may not make ends meet.

Special thanks to guest blogger Austin Carlson for this post.