Many board game companies, in particular small and medium-size publishers, use Kickstarter or other crowdfunding agencies to raise money to produce new games. They will publish an idea, pitch, or prototype of a game to show to potential customers, and offer a copy of the game to anyone who backs the project at a certain level. Often, the companies pledge extras, such as limited edition pieces, alternative art, or a collector’s edition, to people who back the project beyond certain thresholds.
But as backers are charged when a goal is met, the resulting income can create a tax burden that substantially, negatively impacts the publisher’s profit from sales of its new game. It’s a timing issue, one that publishers need to address before launching a crowdfunding appeal.
Publishers use what is categorized as reward-based crowdfunding, where, essentially, a reward is promised to someone who contributes funds to the development of the game. While the IRS is vague on its rules surrounding crowdfunding, it does consider receipts from reward-based crowdfunding taxable income, and generally, taxable in the tax year in which the money is received. If the income is received in one tax year but the expenses are not incurred to produce and sell the game until a subsequent tax year, that’s a timing issue: the taxpayer has all the income but no offsetting expenses. As well, reward-based crowdfunding can also be subject to state sales and use taxes on the same accelerated basis as many states will consider promising the product in exchange for the money as a taxable sale.
HBK CPAs & Consultants works with game publishers to plan and execute their crowdfunding campaigns to address the timing issue and avoid an undue tax burden. We can run projections to make sure the company has enough capital to cover its tax obligations and get their game created, leveraging the timing issues to their advantage when they can, or looking for alternative temporary funding sources while they wait for the right time to receive the crowdfunding. Additionally, here is an article referencing sales tax for board game developers.
Upfront planning can include developing a beneficial timeline for getting the game to market: how long it will take to develop the game and when will the company incur the associated costs. Beyond tax issues, knowing development costs upfront, where the money will be spent and how from start to finish, will help determine the crowdfunding goal.
Cash or accrual
Most small businesses, including startups, find the cash accounting method more attractive as they ramp up. Their expenses are upfront, before they sell product, which means they’ll pay the least amount of taxes and as late as possible. But companies that use crowdfunding get their income upfront, and may need to pay taxes before they have expenses to offset the income.
For those companies, accrual accounting may be preferable, as the funds received are typically not considered income until a sale is made. Advance payments are still income if the company controls the cash, however under an IRS rule, the company can defer “recognition of income,” and therefore the tax burden, on advance payments for a year, if the funding meets certain criteria.
Crowdfunding has become one of the most popular ways for game developers to finance their creative development. But it can also create a timing issue that can result in a substantial tax burden and severely impact the profitability of the game and the company behind it. Publishers can use upfront planning and appropriate accounting measures to secure the financing they need to produce, sell, and profit from their creativity.
For more information on this topic, contact your HBK tax advisor.