If you’ve ever seen a show like Shark Tank, then you’ve probably heard someone say they got their start with something like Kickstarter. It sounds like something as ambiguous and ominous as The Cloud, probably because it’s relative new, but it’s much simpler than The Cloud. Meet crowdfunding, a way used to solicit contributions from a lot of people over the internet.

A major perk of crowdfunding that tends to draw people to it is that it’s an alternative way to access funds rather than get all dressed up and go beg the bank for a loan. Sounds pretty cool right? Well here’s how it works.

Step one, there has to be someone known as a project initiator; the person or organization creating a product of service. They also determine the funding needed, the deadline, the platform, and create the presentation they will show to the backers.

Step two, the platform, in terms of crowdfunding, refers to which organization makes the presentation available to the backers through the internet; such as Kickstarter, Indiegogo, and Crowdfunder. Keep in mind, deciding on the platform depends on what your project focus is. For instance, Kickstarter is for creative projects, Indiegogo is for all types and Crowdfunder focus is on investment.

Step three, the backers who are interested can make pledges through credit cards and the company selected as the platform will use companies like Paypal and Amazon Payments to collect and release the funds. There are two methods to release the funds. All or Nothing and Keep it All. All or Nothing means the funds are charged to credit cards only if the funding goal is met by the deadline. On the other hand, Keep it All means credit cards are charged when the deadline occurs. The project initiator decides whether to go through with partial funding or returning the pledges.

Still sounds pretty good right? Well like anything in life, there are risks involved. The biggest one is making sure that the project is legitimate and that the backers aren’t risking their funds to a scam where no payoff from an investment in a high-risk project. There’s potential for credit cards to be charged if projects don’t meet their funding goal or backers have to rely on the project initiator to return unused funds. Also, when it comes to taxes, it can be confusing as to what to do.

For instance:

  • if a company decides to back a project, the contribution cannot be deductible unless the project is a qualified charity; such as a religious organization or an organization dedicated to stopping animal cruelty, etc.
  • No gift tax is required if a gift from a backer is less than $14,000
  • If the backer receives interest from a project, interest will have to be reported and if the project fails, the backer may be able to deduct the loan as bad debt
  • Taxable income is dependent on the amount received and the number of backers
    • Recipient may receive a Form 1099K from payment vendor
    • Individual has to report to the IRS it’s a gift and not income
    • Nonprofits have to decide filing between tax exempt status or a 990 series tax return
  • If you’re a sole proprietor having taxable income, you will owe self-employment tax on income

As you can see, there are a ton of variables involved when it comes to crowdfunding. However, don’t let it scare you! It could be a great way to get your business off the ground, just make sure to do some research and see which route works for you and your business! Crowdfunding can be a new and exciting method to starting a successful business even though the rules for crowdfunding have not yet been firmly established.