The following article by Kelly Phillips Erb on Forbes.com addresses the tax consequences (or lack thereof) of crowdfunded investments.
Stable 12 Brewing Co (from L to R: Tyler Fontaine, Richard Wolf, Chris Carbutt)
After college, high school buddies Richard Wolf, Tyler Fontaine and Chris Carbutt started playing with a $75 home-brewing kit in the vacant barn on the Wolf family’s horse farm in Skippack, Pa. After two years of experimentation with fermentation and a lot of taste-testing by friends, they decided their craft brews had commercial potential. So in 2012 the three incorporated Stable 12 Brewing Co. and went looking for a business loan. Nine banks weren’t swayed by Wolf’s Penn State degree in hotel management, Carbutt’s in engineering or the craft brewing boom. The lenders wanted three years of financials, which Stable 12 obviously didn’t have.
What next? They decided to try a Kickstarter crowdfunding campaign, posting a bid for $20,000 on Mar. 13, 2013, the same day screenwriter Rob Thomas launched a $2 million ask to make a movie based on his canceled TV series Veronica Mars , starring Kristen Bell as a teenage detective. Thomas booked more than $2 million in a day and $5.7 million in a month, offering such rewards as copies of the script ($10) and an appearance as a background extra ($2,500).
The Stable 12 guys took two months to hit their goal. (On Kickstarter you get the money only if you reach the goal.) They offered their backers two pint-size glasses with the brand’s horse-head logo ($10), a beer growler ($50) and a day at their brewery when it opened ($1,000). Wolf says the partners considered these premiums “a way to say thank you, really,” and were careful not to offer anything that would cost them much cash up front or be hard to produce. Still, Wolf says, they ran into an unexpected snag when it came time to have Stable 12’s 2013 tax return done: Their H&R Block preparer hadn’t a clue how to report their Kickstarter take.
That’s not surprising. While $1.8 billion has been raised on Kickstarter since 2009, the IRS has remained largely and unhelpfully mum on the tax consequences of crowdfunded projects, leaving entrepreneurs, donors and even tax lawyers groping for answers. “It would be nice if the IRS would address the issue,” says Jack Bogdanski, a tax prof at Lewis & Clark Law School in Portland, Ore.
Note that this uncertainty doesn’t relate to crowdfunding in which investors get equity or make loans to a business. The tax rules on treatment of equity and debt, while sometimes complicated, are well established and are no different simply because money is raised from a lot of people on the Web.
But backers of a Kickstarter campaign aren’t investors or lenders in the legal or tax sense—they don’t get an equity interest or hold a note. On its site Kickstarter states: “In general, in the U.S., funds raised on Kickstarter are considered income.” That’s certainly true in some cases.
Example: In February and March Pebble Technology Corp. raised $20.3 million on Kickstarter to produce its Pebble Time smartwatch; all 78,471 backers preordered and prepaid for watches—at a discount. The money raised is revenue to Pebble. Of course, all expenses related to the production of the watches and the costs of the campaign can be deducted against those revenues. (For smaller businesses operating on a cash accounting basis this can present a problem if revenue is booked in one year and expenses aren’t incurred until the next year—so run your campaigns early in the year.)
But income is only part of the story. When a backer contributes more than the market value of the reward he receives, the excess is arguably a gift and not subject to income tax at all. Remember that day at the Stable 12 brewery for $1,000? Tellingly, the purchaser was Wolf ’s dad, who can spend time with him whenever he likes. If Wolf ’s dad had simply given Stable 12 $1,000 outside of Kickstarter and with no reward, it would have clearly been a gift, with no income tax consequences for Stable 12 or the dad.
Gift taxes? They’re paid by the donor. But no gift tax would be owed, since any donor can give as many individuals as he likes $14,000 each a year without it being taxed or even counted against the donor’s lifetime exemption from tax on gifts totaling $5.43 million. (The IRS considers a gift to a company as a gift for the benefit of a particular person or limited class of people—in this case, the three company owners.)
In tax law the motivation of the giver also comes into play when determining whether something is a gift. Gifts, the courts have ruled, are transfers made out of “detached and disinterested generosity” or “out of affection, respect, admiration, charity or like impulses.” That’s not always easy to determine. “It might be quite difficult to prove the motivations of crowdfunding contributors,’’ says Bogdanski, “in which case the burden of proof might play an important role.” Who has that burden? Ordinarily the taxpayer, not the IRS.
Another complication is determining the fair market value of a premium. The market value of two Stable 12 pint glasses is $10—which is what they’re normally sold for. The value of a day with three Millennial wannabe craft brewers? Not $0 (lunch was included) but nowhere near $1,000.
So what did the flummoxed tax preparer for Stable 12 do? She asked her supervisor, who said to treat all the Kickstarter take as a gift. According to H&R Block’s internal instructions, absent IRS guidance “there are no hard and fast rules.”
Using the Kickstarter cash and family loans, the guys have moved $90,000 worth of brewing equipment into the commercial district of Phoenixville, Pa. They offer four brews on tap there and distribute to three bars, with more lined up for when they ramp up production. They’re aiming to be in stores, too, by year-end. Fontaine works at the brewery full-time, while the other two have kept their day jobs—Wolf as a food safety auditor and Carbutt as an engineer. They’re treating this as a serious business, hiring a lawyer and accountant to make sure it’s all done by the book. Whatever that is.