THE QUEST TO GENERATE CASH WITH R&D TAX CREDITS
By: Alex Pak | Director, Los Angeles
By: Alex Pak | Director, Los Angeles
Last year, Forbes reported that the video game industry is growing so quickly that
some analysts predict that it will generate over $300 billion annually by 2025. It is at the top of the list of industries that is in a war of constant one-upmanship. This landscape has sent production costs for AAA titles through the roof, some titles, costing more than $250 million. With this constantly changing landscape, the risk inherent to development increases constantly and for some development studios, especially in the small-to-midsize space, every dollar that can add to the runway is another dollar keeping the studio’s doors open.
Luckily, the US government has in place a program that entitles companies shouldering these risks domestically to offset some of the costs of development: it is called the Research and Development Tax Credit.
What is the R&D Tax Credit?
The federal credit has been around since the early 1980’s and has gone through a plethora of changes, but in its current form, it is a program that allows the game industry to generate tax credits and reduce their tax liability dollar for dollar.
For startups less than 5 years old, the credit can be applied against payroll taxes instead of income tax.
For companies amending their returns to capture credits for past years, those credits are returned as cash refunds on taxes already paid.
A lot. Development begins with conceptualization, the time that your team spends in ideation to develop requirements and specifications. That can mean everything from C-level executives all the way to the developers, even planning meetings you are having count toward the credit. As requirements, look and feel, and technology questions are answered, and as a game begins to take shape, activities like development of UI/UX, environments, game logic, game engine, and design assets all count toward the credit as well.
Once development is in full swing and portions of a game are being polished to be release ready, more and more effort is focused on making the game itself more efficient. This requires extensive optimization, and more often than not, redevelopment of assets within the game itself. These activities in addition to all the testing needed to reveal deficiencies, bottlenecks, and other performance issues also qualify.
Specifically, work that is done by the developers, animators, designers, and testers are all going to push your credit north.
Do Outside Contractors Qualify?
One of the most common questions when discussing the R&D tax credit for the gaming industry is the qualification of 1099 employees and outside development studios doing work for the taxpayer. In both cases, as long as the costs are domestic, the rights to the IP are yours, and the work is not done on a fixed fee for fixed scope basis, up to 65% of the costs can qualify for the credit. If you are in a state that also has an R&D tax credit, these expenses can also help increase your state credits as long as they originate in the state in which you are generating the credit.
With more and more games moving toward cloud-hosted multiplayer experiences, another cost that can help increase the credit are cloud hosting costs. Officially, the IRS considers this the cost of renting or leasing a computer, but all of the development environments that you host for testing and validation prior to pushing a release to your live environment qualifies. Unfortunately, any licensing costs for software that you may be leveraging does not.
What are the Risks?
Not much. There are a few factors that help the gaming industry specifically. First, software development is notorious for high research and development qualification. Second, in most cases, companies already employ formalized project and activity tracking to capture notes on specific development issues in addition to developing conceptual development documentation to substantiate the credits being generated. Finally, the competitiveness in the industry requires companies to continually develop new games or enhancements to existing games making the likelihood of continuous R&D very high.
What Are the Next Steps?
The first thing you will want to do is engage a company that specializes in R&D Tax Credits with a consultative approach to help you identify some of the qualifying costs. With varied federal and state guidelines and compliance documentation requirements, it becomes difficult for companies that are not living and breathing R&D tax credits to stay on top of all the changes. Additionally, when some companies choose to do this themselves, more often than not, it leads to an understating of the expenses which leads to a lower credit. A good R&D tax credit consultant will bring to the first conversation a thorough understanding of your business and areas of R&D thus limiting the amount of time that you and your team spend on non-value added activities.
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