The R&D tax credit and the video game industry complement each other, but companies need to know what activities are potentially qualified for them to take full advantage of these benefits and opportunities. Below are some of the more significant R&D activities that video game companies conduct that will qualify for both federal and state R&D tax credits. The video game industry has exploded into a $100 billion global industry, with over 155 million Americans playing video games in 2015. More companies are allocating a significant amount of their budgets to producing new or improved video games – and many of these costs are qualified research expenses.Key components of the video game industry are playability, speed of the game, stunning visuals, challenging levels and the ability to play on many different devices. The industry has become so highly competitive that with each new game companies must truly innovate to continually attract video gamers.
#1: Software
According to the Internal Revenue Code (IRC), “software” is considered a business component for R&D tax credit purposes and only needs to meet the more broad definition of “research” under the four-part qualification test.The IRS’ new proposed final regulations for internal-use software state that “software that is developed by (or for the benefit of) the taxpayer primarily to be commercially sold, leased, licensed or otherwise marketed, for separately stated considering to unrelated third parties is not treated as internal-use software. All other software is presumed to be developed by (or for the benefit of) the taxpayer primarily for the taxpayer’s internal use.”
The development of a video game falls under this broader definition.
#2: Employee Wages
IRC §41(b)(2)(A)(i) addresses any wages paid or incurred to an employee for qualified R&D activities.For example, employees performing research activities such as game design, game engine development, testing, mobile applications, character animation, artificial intelligence, rendering and graphics are likely involved in R&D activities.
Frequently, video game development departments will include the following personnel:
- Game designers who develop the environment, game logic or core features
- UI engineers who develop design framework and user interface
- Software engineers who develop game code, game engine and platforms
- Graphic engineers who design and code graphics and animations
- 2D/3D artists who design and develop 2D/3D graphics, art and design assets
- QA analysts who are involved in testing of all game features and collecting data
- Product manager who leads cross-functional teams for game development
- Chief Product Officer who initiates product conception and technical direction
#3: Contract Research Expenses
In addition to qualified wages, contract research expenses in the development of video games are qualified research expenses for the R&D tax credit. IRC §41(b)(3)(A) allows 65% of amounts paid or incurred by the taxpayer to any non-employee as qualified research expenses.
Video game companies often hire third-party developers to help build their games. For contract research expenses to be qualified, the two-prong test must be satisfied:
1. The taxpayer has rights to the research results
2. The taxpayer bears the risk of the research costs
Companies need to be careful when they hire third-party developers, because the contract must meet this two-prong test. When reviewing the contract for R&D tax credit qualification purposes, some of the areas to look out for include milestone payments, fixed-price contracts, advances, claw-back provisions and determining where the work is actually being performed (i.e., U.S. or foreign). Only R&D activities in the U.S. are eligible for the tax credit.
#4: Supplies
The last expense eligible for the R&D tax credit in the video game industry is supplies.Under IRC §41(b)(2)(C), the term “supplies” means any tangible property used in the conduct of research other than (i) land or improvements to land or (ii) property subject to depreciation. R&D supplies commonly used in the video game industry primarily relate to devices, platforms or small equipment used to test new game functionality and features.
Some of the supplies in this industry include: video game consoles (Xbox 360, PS4), mobile gaming devices (iPhone6, iPad, Samsung Galaxy phones) and any other testing device or platform.
Please note: Non-qualified costs could be standalone computers that developers use to write game code. The computer will likely have a useful life greater than one year and will be a capital expense that’s not an eligible expense for the R&D tax credit.
The above examples illustrate that video game companies likely have qualified research expenses if they possess the knowledge and the know-how to properly identify and document their R&D activities. When in doubt, using an experienced outsourced tax consultant firm is highly recommended.
Ready to maximize R&D tax credits for your video game company’s qualified research expenses?
