Key Idea: Do not pay 35% income tax on your Kickstarter!
Let’s Talk About Taxes
Kickstarter taxes are confusing. There’s a ton of bad and conflicting advice on the internet.
For example, Kickstarter’s tax help page recommends treating your Kickstarter funding as ordinary income. They recommend spending the money quickly, or paying the tax as ordinary income. This is a terrible idea.
As someone who raised over $200,000 in crowdfunding, and worked with various (paid) tax experts to come up with a tax strategy, I thought I’d share a bit more about how to think about and reduce your Kickstarter taxes.
Disclaimer: I am not a CPA, financial advisor, or accountant. Or a financial professional of any kind.
Giving Away 35% of Your Campaign is Crazy
First, let’s be honest: Kickstarter campaigns are hard, and your margin is lower than you’d hope.
A normal eCommerce business is lucky to have 35% margins. Once you add in Kickstarter marketing costs, Kickstarter fees, canceled pledges, cost of tooling and molding, and international shipping, you’d be lucky to have a 20% margin on your Kickstarter.
If you then turn around and give 35% of your campaign to Uncle Sam in taxes, you’re going to literally kill your business.
The truth is, pre-sales are not a new thing. Tesla, for example, pre-sold $10 billion on their Model 3 in two days. Do you think they then turned around and gave the U.S. government 35%? No way.
Cash Accounting vs. Accrual Accounting
So how can you legally avoid paying taxes?
Use accrual accounting instead of cash accounting.
Most businesses use cash accounting. It’s simpler. Cash accounting means, at the end of the year, you tally up the cash that came in and the cash that came out. The difference is your profit. Whatever cash excess you have, you pay taxes on it.
For most businesses, this makes sense, and is easier to deal with. A restaurant, for example, expects the same steady flow of revenue and expenses every week. Using cash in, cash out makes it easy to manage.
Kickstarter businesses are not like that. You’re expecting $100,000+ to land in your bank account in a few weeks, and then using that money to pay expenses for months. For companies like ours, the accrual method of accounting makes a lot more sense.
Accrual accounting is a different style of accounting, which labels your income as taxable only when a sale is completed. In other words, your income becomes taxable the moment you actually ship your customer their product. This will let you sit on your pile of Kickstarter cash, while paying for manufacturing and other expenses, without having to pay out 35% right away.
Accrual is More Complicated
Accrual accounting has its drawbacks as well. It’s more complicated. You’ll definitely need to work with an accountant on this. Don’t try and Quickbooks it, especially if it’s your first time.
Another drawback is that large cash expenditures are not easily written off. For example, if you spend $20,000 on molds, under cash accounting that’s just a big expense for this year. Under accrual accounting, since you’re not counting cash-in-cash-out, that isn’t a write-off for this year. Instead, it’s depreciated over 5-10 years, meaning the tax writeoff happens more slowly.
Again, accrual is more complex, and you’ll want to work with an accountant on it. But if you launch a successful Kickstarter campaign, this is the absolute best way to make sure you don’t lose a third of your funds right out of the gate.
Hint: Delay Paying Your Taxes
There’s two key reasons not to give away 35% of your campaign. The obvious reason is, you don’t want to pay money if you can avoid it. The less obvious reason is cashflow management.
If you’re launching a Kickstarter, that means you’re launching a new product, and unexpected expenses will come up. We had someone claim a patent on our product, which added tens of thousands of dollars in legal costs. We also had to re-manufacture certain parts, when they failed in the testing process.
Preserve your cash. Even if accrual accounting doesn’t save you money (which it probably will), it will let you pay your Kickstarter taxes later. Later, meaning at the end of the year that you deliver your product. That’s much, much better than paying it right now.
Paying money later is always better than paying it today. Which brings me to another tip:
File for a delay on your taxes. US taxes are usually due around April 15. But you can file for a delay, for free, until mid October. You should do this, even if you have the money in the bank. It’s free. The government is essentially offering you a free 6 month loan.
As a cash strapped startup, you should take all the free money you can get. Wait until the last possible moment to pay your taxes. This gives you more cash to work with in the short term, and more flexibility.
Note: did I mention this is not financial advice? This is not financial advice.
One More Loophole
There is one last loophole I want to mention. If you complete your campaign early in the year – let’s say January or February – you can probably just stick with cash accounting. Your big expenses will all get looped into this year anyway, unless things take over a year to move along.
In this case, it might be better to skip accrual accounting altogether. If you’re planning to launch in December (a horrible month to launch, Christmas and all) it might make sense to delay until January for this reason.
But First, Make Your Campaign a Success
Before you spend too much time thinking about taxes, let’s start with first things first. Let’s make your campaign a success.
To learn how we launched a $200,000 campaign – with no email list and no brand – check out our course here.