Question:
- Is it legal and acceptable for a start up to receive donations from fans or well wishers through its website to fund business operations? For example, having a donation section which enables fans to send donations via checks or accepts credit card payment from the website or paypal account.
- Are there tax implications?
- Does this impede or cause complications if the firm expects to be funded by an angel or VC in the ensuing months.
- Is there any other question i should have asked but did not mention?
Classic Scenario: The business focuses on a particular team or sport; publishes fan content and creates a professional social media website that aggregates fans of that particular sport and it facilitates their viral communication on its platform. Examples include Lakers-Fan, Yankeestown and The Red Sox Fan Site
Donation is used fund commuting, interviews, video processing, website maintenance, hosting cost, consultants and much more.
Answer:
Although in the context of for profit businesses the concept of “donation” or “gift” –a nontaxable contribution–doesn’t usually fit, “fan” donations to your startup business might not be taxable income to the Company. The fan donations should be for the purpose of adding to the capital of the Company, cannot be contributed in payment for specific goods sold or services provided by the Company and must be employed to generate additional Company income—in other words, the donations must benefit the Company itself and not constitute some form of a quid pro quo payment.
Where you could run into trouble is if the IRS considers the donations to be “solicited “ by the Company. If they are, the dollar amount of the fan donations could be viewed as additional taxable Company income. Just having a place on your web site where fans can make a donation to the Company “in gratitude” for the Company’s pursuit of its mission, without a public campaign for such donations or your web site turning into a ”beg-a-thon” for them, may not qualify as solicitation. But a detailed legal analysis, based upon the specific facts surrounding the donations, is very important here.
If you intend these donations to constitute a significant portion of the Company’s operating funds during its startup phase, and you plan to seek venture capital or other institutional financing for the Company, I’d seek a formal memorandum from your counsel or accountants on the issue. The folks that finance your Company will want comfort that you’ve paid all applicable taxes along the way. If you don’t pay taxes on these contributions when you should have, not only will it blow your credibility with those folks, but it will leave you with an expensive bill due to the IRS and state taxing authorities—not only will you owe the back taxes that were unpaid but you’ll owe interest and penalties on top of it.
So, be careful!
Question provided by Samuel O.
Answer provided by Peter Rothberg – (website, LinkedIn Twitter), Partner at Duane Morris, Ultra Light Startups sponsor and counsel.
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