Pay Caesar His Due

Sorting out the taxing dilemma of paying taxes on crowdfunding campaigns at Kickstarter and beyond.

The Magazine
Feb 17, 2014 · 17 min read

Disclaimer: I am not an accountant, and my advice about what to look out for should not constitute legal or tax advice. Consult a professional after learning the kinds of questions you should ask before and after a crowdfunding project.

I almost had a cash flow and tax disaster slam together after a recent Kickstarter campaign ended. I thought I had crossed all the t’s in tax and dotted the i’s in income before I started — and I missed a few crucial planning steps. I’m here to share what I learned from a successful campaign.

Budgetary bungles

Rewards-based crowdfunding — à la Indiegogo, Kickstarter, and an increasing number of other sites — could collect well over half a billion dollars in 2014 for project organizers. While much attention is paid to the blockbuster campaigns that rake in hundreds of thousands to millions of dollars, the majority of revenue comes from projects that collect from hundreds to low tens of thousands of dollars. There are many times more projects at this funding level than at the ones that garner headlines.

Many of the folks who run these campaigns may never have brought in business revenue before, or at least not on the scale of what the project raises. This means they may not have previously consulted an accountant and may have little or no idea about the issues involved. I’ve run businesses on an annual revenue scale of $50,000 to $500,000 (and I’ve been involved on the tax and revenue periphery of some much larger firms), so I thought I was prepared.

When I put together the budget for the Kickstarter campaign to produce a book from the first year of The Magazine’s articles, I thought I had accounted for everything. I had negotiated fees with the designers, received estimates from the printers, set reprint fees with contributors, calculated domestic and international shipping costs, and contracted a cover artist. My production budget has turned out very accurately.

And I had, of course, considered tax — I just hadn’t considered it well enough. Because the project was designed to break even — and plow any additional revenue above the goal into additional content for the book and into site and app updates for the publication — I thought I wouldn’t show any effective profit on the endeavor. We’d have some extra hardcover books and the ebook left to sell afterwards. (The Magazine is organized under a single-member LLC, Aperiodical LLC, and profit above expenses, even if I leave all the cash in the business accounts, flows through to my personal return as taxable income.)

But I hadn’t really put a precise number, as I should have, on the tax owed below the federal level. And worse, city, regional, and state revenue and taxation departments aren’t fully aligned on how to account for crowdfunding revenue. Kickstarter suggests that most funds are taxable income; Indiegogo offers no specific advice on its site. Some government entities have made up their minds: Canada said in October 2013 that all crowdfunding revenue counts as business income.

(Federally recognized nonprofits with a 501(c)(3) or similar designation may be exempt from tax; some groups also work with fiscal sponsors. Jean MacDonald and I talked about this extensively in a podcast episode about a group she founded called App Camp for Girls.)

In fact, there’s some wiggle room over whether someone without an established business who uses crowdfunding and promises the equivalent of gifts and thank-you notes to fund a project — like postcards and downloads as the rewards for funding making a freely distributed film — needs to count the revenue as taxable for business! It’s perfectly legal for thousands of people to send you gifts in the form of cash without you paying any tax on those gifts. Crowdfund Capital Advisors, a group that consults on investment and other forms of crowdfunding, suggests from expert advice that if no tangible reward is given, then there’s no sale, and thus potentially no tax; the same is true if the reward is tiny compared to the item’s production or market cost.

But it depends entirely on how local, state, and federal taxing authorities want to treat that revenue and on whether they pay enough attention or receive enough information from other parties — such as a required form from payment processors discussed below — to track you down if you fail to meet the rules that they intend to enforce.

Let’s start with some business basics before I go into the specifics related to crowdfunding.

Business basics

In the United States, if you accept money for goods or services above a certain threshold, or at all for certain kinds of work, you probably require all of the following:

  • A business license in every city in which you work in person. For freelancers, this typically means the city in which you have a home or other office. If you make something and deliver it, it’s possible you need a license in the destination city.

And you may owe all of the following kinds of tax:

  • City or county business. Most municipalities tax all income earned in their jurisdiction, although many also exempt you from paying tax if earnings are below a certain threshold in a quarter or a year. However, you typically have to report income, even if you don’t have to pay anything.

Are you crying yet? There’s more.

It’s the most taxable time of the year

The very worst possible time to launch a crowdfunding campaign is late in the year. This is because taxes in America and most countries are typically owed on income received in a given calendar year, while expenses may be deducted only in the calendar year in which they occur. If they’re not the same year, it can have a huge impact on one’s cash on hand.

Of course, I launched my Kickstarter campaign in November to finish in mid-December. I had a reason, which I’ll get to later.

You can have a business with a “year” that doesn’t run January to December, but once you pick it, it’s very hard to change. And you can choose to calculate taxes on an accrual basis, in which revenue and expenses can be reported when they align (useful for selling things and maintaining inventories) instead of necessarily when they occur. But this is subject to a host of rules that make it useful only for specific businesses, and it isn’t specifically useful for crowdfunding unless your business is already organized on that basis.

Because crowdfunding campaigns can take months or even years to fulfill, if you launch a campaign late in a year, all the revenue comes in late in the year and is taxable in that year, whereas expenses come in the next year or even a subsequent one for big projects. Sorry for all the italics, but it’s an important point to make.

You see the problem. In our case, we raised over $56,000 in 2013 (before subtracting Kickstarter and credit-card fees), and nearly all of that money was for services that would be rendered in 2014, such as printing. Because we would eventually incur those expenses, they would offset our taxable income in 2014 — but we still needed to pay the tax for 2013! That can cause a cash crunch if you haven’t planned for it.

The related problem was in how Kickstarter pays out its funds. Kickstarter doesn’t collect a penny directly, but uses Stripe to handle payments and disburse money. (Kickstarter formerly worked with Amazon Payments.)

With Kickstarter, when you sign up as a project creator, you also register with Stripe, and you agree that of payments collected, 5% of the gross (the total charged before fees are subtracted) is paid as a fee to Kickstarter. Stripe charges the full amount, subtracts its 3–5% fees, disburses 5% to Kickstarter, and pays you the remainder. (States that have gross business taxes, like Washington, calculate tax on the amount charged before Kickstarter’s fee and credit-card fees.)

Stripe doesn’t pay out (per Kickstarter’s rules) for 14 days after the campaign ends. However, because they are a payment processor acting on your behalf, the moment they charge a credit card or accept other payment, it’s a taxable event for you.

And if you have more than 200 payments (separate charges) or $20,000 collected for you in a calendar year, Stripe files a form (the 1099-K) with the government to report it. The $20,000 total may be high, but most successful crowdfunding campaigns have more than 200 backers. You can’t pretend to receive the money when it lands in your bank account, in other words; the IRS and local authorities won’t accept that logic.

My campaign ended December 19, 2013. Fourteen days would put us into 2014. But we wanted to lock in expenses in our 2013 tax year to prevent a cash-flow crunch in which we paid tax on 2013 and got the deduction for expenses in 2014. We had enough cash on hand, though it would be tight. However, Amazon Payments (then Kickstarter’s payment processor) released most of our cash immediately — possibly a mistake, although other campaign managers said the same had happened to them — and held about 10% on the rolling 14-day release schedule.

I paid all outstanding invoices before December 31, even if they were fresh (we typically pay invoices in 14 to 28 days), and I wrote checks for reprint fees to all the contributors. I paid the invoices of my designers, as well as other folks collaborating on the project, in full for the entire project. It’s rare to be in a position in which all the cash is on hand and you know you’ll need to pay it all out in a short period of time. Because we wound up shifting printers, I didn’t pay a deposit to the printers until January, sadly. (I asked several contractors if they minded being paid at the butt end of the year, because I would be increasing their 2013 tax burden. None objected.)

Let’s suppose you’re a sole proprietor and your Kickstarter campaign completes, as mine did, in 2013, but you cannot pay a penny of your expenses until mid-2014. It can be a severe problem for your bank account, even though the actual net amount of tax owed for 2013 and 2014 together doesn’t change.

Let’s say you’ve incurred enough taxable income (after deductions, exemptions, and the like) to push new dollars earned into the 25% bracket and your Kickstarter raises $50,000 after payment and other fees.

In the simplest case, by April 15, 2014, you’ll need to pay $12,500, or 25%, of that $50,000 as federal tax for 2013. That is cash you’ll no longer have on hand when, a few months later, you need to write checks to pay for expenses related to the project.

Now, if we also pretend that 100% of those expenses comes directly off your taxes, you owe $12,500 less in 2014 — so you effectively get that money back. But if the Kickstarter money is way out of scale with your regular earnings or those of your business, you won’t get it back by reducing estimated tax payments — you won’t see the money again until you file 2014 taxes in early 2015 and get a tax refund. That’s not helpful if you need to pay an invoice in June 2014.

I managed to hit an interesting position in prepaying taxes that’s entirely legal and about which I consulted with a tax professional. (As always, consult!) If you are required to pay estimated taxes (and are properly doing so) during a given year and want to avoid penalties on late payment, you need to pay either:

  • 90% of the tax you ultimately wind up owing for that tax year

For example, if you owed and paid $25,000 in taxes for the 2012 tax year, and across the four quarterly estimated payments for 2013 you paid $25,000 (100%), even if your 2013 tax burden works out to $50,000, you won’t be penalized for paying the remainder by April 15, 2014. (Likewise, if you owed $25,000 for 2012, but estimated correctly that you would owe only $10,000 in 2013 and paid at least $9,000 ahead of time, you don’t owe a penalty either.)

In my case, because I have a sole proprietorship for my freelance work and a single-member LLC for The Magazine, I was in a sweet spot (see illustration):

Image for post
Image for post

The distribution of net income, expenses, and tax payments relative to the Kickstarter.

  • I made sure by January 17, 2014, the due date for fourth-quarter 2013 estimated taxes, to pay a total for 2013 that was over 110% of my 2012 taxes, to be on the safe side. My 2012 taxes were less than my 2013 taxes by more than the amount of the 2013 Kickstarter liability, making this math work.

Because of this alignment of estimated tax owed and paying out expenses, I wound up with a lucky conjunction of estimateds and final tax payments on the same day. If expenses had crept into second quarter, this could have caused a cash crunch, one I didn’t fully plan for.

For a person or business for which the Kickstarter is larger than, say, their annual income, this cash-flow crunch could be devastating. The creator of Printrbot raised $830,827 toward a $25,000 goal. But the project funded in December 2011. You see the problem. He told Wired in 2012 that he was hit with an IRS “bill” (more likely, he talked to an accountant who told him what to pay for 2011 taxes) of $330,000. However, the company was able to deliver its hardware and continues to expand.

So why did I launch my Kickstarter at the end of the year? It comes from the limits of being a one-man band supported by a host of gig musicians. I had originally hoped to have the time to select all the work we wanted to feature in the book by October 10, 2013, our one-year anniversary, and to work with the designers on the prototype to release it then.

Instead, due to the demands of running the day-to-day business and travel, we couldn’t launch for five weeks after that. It was both the earliest we could launch in terms of pulling together all the pieces, and the latest to finish up before Christmas. Launching an anniversary edition in January would have been odd (three months late) and at a time when people were still dealing with 2013 holiday bill hangovers. (I have plans for a second-year book that will be announced and up for pre-orders before the second anniversary and that will ship in November 2014.)

Sales and retail: local, interstate, and foreign

My biggest goof in timing and preparation, however, was not fully sorting out my state business and sales tax burden. Fortunately, as I spoiled for you earlier, it all worked out. But I’ve heard horror stories from other folks, especially in larger states like California and New York, which are aggressively ensuring that every penny of sales tax is paid.

Washington State, like many, has different categories of business tax, depending on whether a sale is wholesale, retail, service, or in a variety of highly specific, lobbyist-backed special categories. (Split-pea subsidies, for instance.)

I had assumed based on previous conversations with the state revenue department that only some of the Kickstarter would be taxed at the retail rate, that some would be classified as advertising (podcast sponsorships), and that some would count as services. Far too late in the process, I made a more detailed study of the rules and asked my accountant. He suggested that I get a ruling from the state. In Washington, as in other states, the revenue department can issue official rulings that may be appealed, but if you accept the ruling, it becomes the rule under which you pay tax related to the question. You can’t be charged additional tax for complying with the rule, even if they later change the guidelines.

The state declared that 100% of my Kickstarter gross revenue — before fees, as our business tax has no exemptions or deductions for expenses — should be counted as retail sales. However, because it was a retail sale, I would be obliged to pay business tax and sales tax only on purchases delivered to residents within Washington State. The state ruling notes, in part:

All of the items that you listed (digital subscription, electronic books, and T-shirts) are retail sales when sold to consumers in Washington. Retail sales tax applies based on the selling price, and the gross income is taxable for B&O tax under the Retailing classification. When reporting your sales, you should include your gross sales amount and then claim an Interstate & Foreign Sale deduction, under both the Retailing B&O tax and the retail sales tax, for those sales with delivery to consumers outside the state.

Except, of course, I hadn’t asked the folks who pledged for only electronic rewards where they lived — only their email addresses. And a good subset of backers hadn’t filled out their surveys (and still haven’t). I had set up an address-update system on my Web site, and I emailed backers asking them to provide a state within the United States, or a country, which would meet the requirements for state reporting. Only a small percentage did.

Fortunately, I was able to get an accounting from Kickstarter by ZIP code and country of each completed pledge: under 10% of the revenue from the campaign came from Washington State residents, and I was thus able to file correctly with the state. (The state got about $750; Seattle, about $150.)

If you’re in a state that collects sales tax, therefore, it’s vitally important to ask everyone where they live. Each state has different rules about your good-faith effort: Washington’s are fairly liberal, as I just need affirmative documentation that someone told me where they live. (And I have a physical address for every item I’m shipping.) Other states may have more stringent rules.

(One more tip: my accountant says that Washington State requires that I inform customers that sales tax will either be included or added to purchases. Kickstarter doesn’t let you automatically surcharge sales tax, which varies by delivery ZIP code, in any case. I chose to include it. Other states may also have this requirement.)

I’m the eggman

Taxation for most people is probably the most boring subject they have to deal with. And I admit that I don’t love accounting and tax regulations. However, in the world we live in, you can avoid neither taxes nor death (perhaps there’s a Kickstarter for the latter?), and preparing better than yours truly could save you time, fuss, audits, and penalties.

Government authorities at all levels need to wake up to the reality of the $500,000,000 or more that will be disbursed in 2014 to individual artists and smaller businesses. These people, including me, want to be compliant but most of us lack the expertise or money to be sure we’re following the rules correctly. My own journey shows what’s necessary to do the right thing.

Americans: contact the tax office in your state for more information: AlabamaAlaskaArizonaArkansasCaliforniaCaliforniaColoradoConnecticutDelawareFloridaGeorgiaHawaiiIdahoIllinoisIndianaIowaKansasKentuckyLouisianaMaineMarylandMassachusettsMichiganMinnesotaMississippiMissouriMontanaNebraskaNevadaNew HampshireNew JerseyNew MexicoNew YorkNorth CarolinaNorth DakotaOhioOklahomaOregonPennsylvaniaRhode IslandSouth CarolinaSouth DakotaTennesseeTexasUtahVermontVirginiaWashingtonWashington D.C. • West VirginiaWisconsinWyoming

Glenn Fleishman is a freelancer journalist and regularly turns to crowdfunding to advance his creative endeavors.

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Thanks to Matthew Amster-Burton

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A fortnightly periodical of features for curious people. Get The Magazine app for iPad, iPhone, & iPod touch in the iOS App Store, or subscribe on the Web.

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Narrative non-fiction writing from a fortnightly periodical for curious people with a technical bent.

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Written by

A fortnightly periodical of features for curious people. Get The Magazine app for iPad, iPhone, & iPod touch in the iOS App Store, or subscribe on the Web.

The Magazine on Medium

Narrative non-fiction writing from a fortnightly periodical for curious people with a technical bent.

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