This story first appeared in the April 5 issue of The Hollywood Reporter magazine.
Now that Kickstarter has hit the mainstream with almost $4 million raised (and counting) for a Veronica Mars movie it's time to think through the legal consequences of using the service -- for both contributors and recipients.
Kickstarter and its ilk are basically a donation model where wannabe entrepreneurs submit ideas and solicit funding from the public, usually in exchange for some small goodie. The contributors do not receive equity, so the practice is not regulated -- yet.
In the case of Veronica Mars, show creator Rob Thomas and producers offered contributors (a) a copy of the script; (b) a speaking part in the film (for $10,000); (c) T-shirts; (d) DVDs; and (e) signed posters. The good news for recipients is that the offerings should not be subject to federal or state securities laws because they do not include an investment opportunity. However, if producers have not accurately stated the facts regarding their project on the website, or if they do not live up to their promises, they might find themselves subject to state and federal laws prohibiting mail and wire fraud, unfair competition and false advertising. So it behooves producers using the Kickstarter model to make full disclosure of all material facts, which is similar to the standard under securities laws.
One law of particular concern to the Veronica Mars offering is California Labor Code Section 450, which prohibits charging anyone a fee to apply for or accept employment. The California Division of Labor Standards Enforcement has come down hard on anyone who charges aspiring actors for auditions or for a role. Given that the Veronica Mars campaign expressly offered and accepted $10,000 for a speaking role, I would not be surprised if producers receive an impolite letter from the department.
At some point, they also might get a letter from the IRS informing them that the "donations" are taxable income, unlike an equity investment or a loan. I suspect that some Kickstarter recipients overlook this issue or plan to treat the funds as a tax-free "gift." However, a tax-free gift requires that the payment be made out of "detached and disinterested generosity." For almost all donation crowd-funding, there is some consideration offered for the donation (albeit often at a much lower value), and this consideration is enough to take the donation out of the tax-free-gift category and move it to the "tax me now" category. This might be acceptable to recipients who can immediately deduct their production costs under IRC Section 181 (permitting the deduction of the first $15 million of the cost of producing movies and TV in the U.S.), but this section expires at the end of 2013, recipients might not qualify for it, and it does not apply for state-tax purposes. For recipients who do not have an offsetting deduction, the tax hit will be substantial.
On the flip side, contributors can attempt to deduct their payments as "charitable donations." But such donations are only deductible if they are made to a qualified 501(c)(3) organization, which most recipients are not, and there is no consideration received in exchange, which also is generally not the case. The payment will not be deductible under any other theory, so in most cases contributors are out of luck.
Schuyler Moore is a partner at the Los Angeles office of Stroock & Stroock & Lavan and the author of The Biz: The Basic Business, Legal and Financial Aspects of the Film Industry.