Posted by Jeffrey Feingold on 02.21.24

The downturn in the US economy in recent years has led U.S. game developers to seek ways of cutting costs, including sub-contracting or outsourcing game development. In order to keep these and other jobs on American soil, Congress created an R&D credit to give American companies, including game developers, a very lucrative incentive to continue their development here. This R&D tax credit was enabled in 1981, but it has been expanded, extended, and better defined over the years. It has become more inclusive. Businesses that once didn't qualify, may now reap great rewards. It is intended to not only create high paying tech jobs, but also to encourage American invention and development.

What are the benefits of the federal R&D Tax Credits?

The R&D Tax Credit is one of the most significant tax incentives available. It can represent a significant financial advantage to businesses, allowing both reduced tax liability and cash back for reinvestment or other needs. Some of the benefits are:

• 20% tax credit.
• The R&D Tax Credit is a bottom-line, dollar-for-dollar credit against income tax due - not a deduction. This is more money than a deduction.
• The credit can be retroactive. Businesses can claim R&D Tax Credits for open tax years (usually 3-4 years), and often for some prior "closed" tax years.
• If you can't use the credit this year, you don't lose it. Federal R&D Tax Credits can be carried forward for 20 years.

How did the states respond?

Many states have followed suit and also enacted R&D credits. Each state has its own rules.

• Some states require registration while others have you just enter the credit on your taxes.
• Many states offer R&D credits with carry-forward provision.
• Some states for the sale or transfer of R&D state credits.
• Some states will "buy back" your state R&D credits for cash.
• Some states have limited funds, so filing early is very important.

How do I qualify?

These tax incentives are not just for the big companies. They are powerful ways to maximize after-tax profits for startup developers and independent game companies, too. A simple four-part test helps to determine qualified R&D activity:

• Does your company undertake activity intended to develop a new or improved product or process for yourself or your customer?
• Is this activity technical in nature (computer science counts)?
• Does this activity seek to eliminate technical uncertainty (this can be uncertainty as to technological feasibility but it does not have to mean the potential of failure to succeed - instead, the uncertainty can also mean as to the nature of the design/design elements)?
• Does this activity follow a process of experimentation (this is essentially your efforts to overcome the uncertainty and to attempt to succeed in your efforts to make something new or improved or to develop a new or improve an existing process)?

Software development activities that could qualify:

• Designing software, databases, upgrades, new features

• Flow charting
• Testing different coding solutions
• Beta testing or prototyping
• Debugging and patching
• Optimization of code

Software development activities that will not qualify:

• Development of software for internal use.
• The exception being that the software must be unique and differ significantly from the prior software, involves significant economic risk, and is not commercially available.

Other incentives that should be looked at include;

•  The 100% tax deduction under section 174. All software falls under this section.
•  The 9% domestic production tax deduction under section 199.

Where do we start?

Talk to your CPA about these qualifications, or contact Tax Point Advisors for a free, no-risk, no-obligation estimate of tax savings. There are several requirements that must be met to qualify, but the savings is worth the investment of time and energy to investigate it. It is absolutely necessary to keep detailed records of expenses.