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How to Minimize Risk When Crowdfunding on Kickstarter

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Mashable by Nellie Akalp | July 30, 2013

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To date, more than $680 million has been raised on Kickstarter, as crowdfunding becomes an increasingly viable option for startups to raise much-needed funds without the help of VCs, angels or banks.

For a young, bootstrapping startup, crowdfunding is often seen as fast money that will help you build out the product or app you and your team have always dreamed about. Whether or not a project ultimately reaches its funding goals, it’s still relatively quick and easy to post your pitch and see what happens.

However, amid all of the hype and excitement surrounding crowdfunding, some of the less glamorous (but extremely important) aspects of running a business often go overlooked — particularly taxes and liability.

Liability Issues With Crowdfunding

When crowdfunding turns into a platform for taking pre-orders for a yet-to-be-finished product, there are inevitable risks. We’ve all heard stories about high-profile delivery delays like the Pebble smart watch, but they’re hardly an anomaly. A report by CNN Money found that 84% of the top 50 funded projects on Kickstarter in 2012 shipped late. When excited backers expect the same smooth fulfillment process as ordering a product from a retailer like Amazon, disappointment, frustration and worse will inevitably ensue.

It's doubtful that anyone actually creates a Kickstarter campaign with the sole intention of weaseling money out of people. However, with any technology or creative project, things don’t always go as planned — and some well-intended projects fold before they’re ever brought to fruition.

For this reason, it makes sense to launch a Kickstarter campaign through a legal business structure, such as a Limited Liability Company (LLC), as opposed to posting it as an individual. An LLC or other structure offers a layer of protection that can essentially shield your own personal assets from that of the business. So, if something should happen to your project or business, the business is liable for it, and not you personally. Make sure your LLC or corporation is officially established and then conduct all business and enter contracts through the LLC or corporation.

Crowdfunding and Taxes

The tax consequences of crowdfunding campaigns can catch project creators off guard. When you raise funds for your business through other sources, it’s considered a contribution to capital and is usually not taxed. However, funds raised on Kickstarter are considered income, and creators are issued a 1099-K (at least when they raise more than $20,000 and have more than 200 transactions).

Project creators can often offset this income with deductible expenses related to their project. However, some people run into trouble when their Kickstarter funds fall in a different tax year than their major expenses. For example, you might need to raise money first, then you can start spending it to build the product. To counter this scenario, some project creators opt to form a C Corporation so they have more flexibility in defining their fiscal year for tax reporting purposes (and therefore, make sure their Kickstarter income and expenses occur within the same reporting year).

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