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I run a Minecraft server and there is a donation button so players can help support the costs. I pay out of pocket for the rest, it's $125/mo.

The money they donate goes right to paypal which is where the automatic payment to the server happens, so it works out nice as it will just pull the remaining amount from my account.

Do I need to claim the donations as income? Can I somehow write off the server costs? Etc.

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2 Answers

up vote 7 down vote

Its is considered a "hobby" income, and you should be reporting it on the 1040 as taxable income. The expenses (what you pay) are hobby expenses, and you report them on Schedule A (if you itemize). You can only deduct the hobby expenses to the extent of your hobby income, and they're subject to the 2% AGI threshold.

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up vote 7 down vote

Technically, this is considered "income" for you, and is actually not considered a "donation" for your donors, but is instead a "gift" (not tax-deductible for your donors). So, you are technically required to report it, and there is a pretty significant audit trail that can be followed to prove you made that money. I don't know if PayPal is required to file 1099s for payments received, but if you've ever received such a document, so has the IRS, and they'll match it to the income you claimed and see a discrepancy, triggering an audit. Depending on the amount that it affects your taxes (it can be significant; if you have a $50k/yr day job, you'd owe the government 25 cents on every dollar donated), they can let it slide, they may simply dock your next return, or they may come after you for interest and penalties or even charge you with criminal tax fraud if they could prove you maliciously attempted to conceal this revenue.

Now, if you already itemize using a Schedule A, then you can erase this income by deducting the costs of the server, not to exceed the amount of the donations. The best you can do is offset it; you cannot use this deduction to reduce taxable income from other sources. Also, you must itemize; you can't take your standard deduction, and with a maximum possible deduction of the actual costs of running the server ($1500, IF you receive enough donations to fully pay for it) compared to one person's standard deduction ($5800), you'll want to take the standard deduction if you don't have other significant deductions (medical expenses, mortgage interest/property taxes, etc).

If you were charging users a monthly fee for use of the server, then you've basically created a de facto sole proprietorship, and you would still have to count the fees as income, but could then deduct the full cost of running the server. You'd fill out a Schedule C listing the revenue and expenses, and back them up with statements from your ISP/hosting company and from PayPal. Now, this would apply if you were running the server with the primary goal of making a regular profit; Schedule C cannot be used for income from a "hobby", undertaken primarily for enjoyment and where a few bucks in revenue is gravy. Whether you think you can get away with that in your current situation is your prerogative; I don't think you would, given that the donations are solicited and optional, and thus there is no expectation of ever turning a profit on this game server.

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4  
It is most certainly not a gift. And the $13K does not apply. It's income, and those expenses can be deducted from it, so if OP is still out of pocket, it's a wash. But if he starts to run a profit, tax is due. – JoeTaxpayer Jul 30 '12 at 21:39
The OP is not a non-profit; these donations are indeed "gifts", which must be reported. No, the OP wouldn't have to worry about the gift tax; a large donor might. The IRS would look at this situation as being little more than a "hobby", which as I stated is not valid as a source of business revenue or expenses; if it were then I would be saving a ton by deducting for musical instruments, just by going to the park, opening my case and busking for pocket change "regularly". Filing a Schedule C with a significant operating loss on a video game server would be a huge red flag to auditors. – KeithS Jul 30 '12 at 23:47
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Keith - in effect, the OP has a 'donationware' situation, he provides a service, but via a button, solicits money. The "donors" get a service in return. But the tax has zero to do with gift tax or the gift tax rules, it's income, plain and simple. It's not even in a grey area for the fact that he solicits the money. – JoeTaxpayer Jul 31 '12 at 1:00
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That's true. I think we're saying the same thing but disagreeing over it. The OP must count the donations as personal income (we agree there). The OP CAN deduct expenses up to but not exceeding the amount of the donations by itemizing it on Schedule A (meaning OP must itemize to take this deduction, and cannot reduce the amount of their income below what they'd have made if they didn't receive any donations). The OP cannot file a Schedule C and call the game server a business operating loss, reducing net taxable earnings, as this game server would almost certainly be viewed as a "hobby". – KeithS Jul 31 '12 at 1:24
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@KeithS - I reversed my down-vote as I think we agree, and saw you extensive edit/update. I'm not 100% certain that he would need to itemize to use the expenses to just offset the costs. I'd like to see a citation or hear from others as well. But the main point, "not a gift" we agree. – JoeTaxpayer Jul 31 '12 at 12:04
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