Developing a game isn’t cheap. Even if you have a team of 3D modeling pros with lots of programming experience and heaps of creativity, the hours you’ll all dump into building your game are hours people expect to be paid. And even if your internal team can handle the bulk of the development process and is willing to work on a tight budget until the game launches, you might need to pay third parties for things like music and marketing.
Ultimately, by the time your new game hits the market, it represents a serious investment. Obviously, you’re hoping for some serious sales to recoup that cost — and then some. But people buying your game isn’t the only way you can offset your development costs.
Under Section 41 of the Internal Revenue Code (IRC), companies have the opportunity to claim a tax credit for their research activities. You can reduce your tax liability by up to $500 with this credit and a lot of the game development process applies, so it’s definitely one you shouldn’t overlook.
The more your company spends on qualified research expenses (QREs), the more your credit grows. Here are three areas game developers can often apply what they’re spending to shave down their tax liability.
#1: Offset payroll
One of the biggest potentials for tax savings from IRC Section 41 comes from your payroll. It allows you to apply “any wages paid or incurred to an employee for qualified services performed by such employee.” In other words, if you’re paying people for qualified research expenses, their salary or hourly wages can count here.
So, what’s a qualified research expense? Per the IRC, it’s anything that’s:
- Done to discover information
- Technological in nature
- Meant to be used to develop a new or improved business component
- Part of a process of experimentation to create or improve function, performance, reliability, or quality
In other words, you don’t need to be working in a sterile lab environment to qualify for this tax credit. Instead, there are quite a few job titles in the game development world that are eligible to fall under this umbrella. Those include:
- 2D and 3D animators
- Audio engineers
- Game designers
- Instructional designers
- Quality assurance engineers
- Software develops
- Technical directors
- User interface (UI) developers
- User experience (UX) developers
For in-house employees, up to 100% of their salary can go toward the total you apply to calculate your R&D tax credit (assuming 100% of their workday goes toward qualified research activities).
If you contract out some of these roles, up to 65% of their 1099 wages apply.
#2: Supplies (including cloud hosting)
Section 41 lets you count what you spend on research supplies toward your credit as long as that money doesn’t go toward land or supplies that are subject to the allowance for depreciation. Unfortunately, that means that most computers don’t count since they’re generally depreciated.
Still, though, plenty of other supplies you may need can go toward your total. You might be able to get a tax credit for things like:
- Game consoles
- VR headsets
- Gaming controllers
- Mobile gaming devices
Also, if you rent computers, you may be able to count that cost toward your R&D credit. To qualify as applicable computer rental expenses, the computer needs to be owned by someone else, located offsite, and you can’t be the computer’s primary user. So if you ever have overflow and you have to send your team elsewhere to use a computer, record what you pay and ask your accountant if it can go into your R&D tax credit total.
Finally, and perhaps best of all, cloud computing services do meet the criteria laid out in Section 41. So if you’re like many other game developers and you’re using Amazon Web Services, the cost of AWS can likely count toward your tax credit.
#3: Alpha and beta testing new software or hardware
Remember, something can count as a qualified research activity when its goal is to create or improve functionality, performance, reliability, or quality. That means alpha and beta testing of both hardware and software generally count.
This area can get murky fast, though. For example, Section 41 specifically says that surveys and studies don’t count as qualified research expenses. You can’t just have people play and ask for feedback. You need your alpha/beta testers to have specific research-based goals, like identifying and correcting bugs or improving gameplay mechanics.
Ultimately, if it’s leaning more toward market research than actual testing to improve the game, you likely can’t claim the credit for the cost. Talk with your accountant to get a better idea of when testing costs can go toward your R&D tax credit.
Claiming the credit
This outlines a few ways game developers can use IRC Section 41 to reduce their tax bill, but this is just a start. Most states also offer some sort of tax advantage for R&D, and because game development is innovative and technological in nature, you can often apply these perks to lower your tax bill.
To get the most out of potential R&D tax savings, do two things:
- Carefully document any expense you think could count. The IRS and state tax authorities want proof before they’ll let you shrink your tax bill (or apply the credit as a carryforward, if you’re operating at a loss and don’t have a tax liability yet). Make it a habit to record any money you spend that you think could count as a qualified research expense. You’ll need receipts, invoices, etc. to show tax authorities that you’ve spent money in appropriate R&D areas. You should also save anything that validates that the money was spent for research purposes (e.g., debugging reports).
- Meet with an accountant with experience in this tax credit. The Internal Revenue Code is a huge document, and not all accountants know all niches. Find a certified public accountant (CPA) who has helped others claim this tax credit. That way, they’ll be able to guide you through the entire process, from identifying expenses that qualify to actually filing the required paperwork to claim the credit.
For that second point, we’re here to help. We even have a handy R&D tax credit calculator to get you started.
If you want to talk to accountants who specialize in helping startups take advantage of Section 41 of the Internal Revenue Code, reach out to get started.