R&D Tax Credit Software – How The US Tax Code Rewards Game Developers

Ever since the pandemic hit globally in 2020, many people have spent unprecedented amounts of resources on digital media products. And this has been advantageous to software-based businesses, especially the video game industry.

However, this setup has also pushed digital media developers to evolve and innovate continuously to stay in the competition. And while it can be costly, there is a way to offset these expenses. We have R&D tax credit software to thank for this. Research and development tax credit offers a substantial amount of credits for many of the processes involved in game development.

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R&D Tax Credit Software And What It Covers

When we hear the term “research and development,” we often assume that it is only about scientific endeavors. But in essence, if an activity supports new or improved practices, it most likely will qualify as research and development. In short, R&D applies to a multitude of business types and industries. Furthermore, research and development do not only cover formulas, processes, or physical devices.

It also encompasses the scope of performance optimization, software, innovative techniques, and quality assurance. It means that even software developers (and those working in video game companies) can claim the R&D tax credit. Below is a list of actions that may qualify for R&D tax credit software:

  • Beta testing new software and hardware versions
  • Developing and improving algorithms
  • Engineering devices for improved performance
  • Improving the manufacturing process for gaming system parts.
  • Innovating technology for a smart and interactive content

These are considered payroll expenses, which means that the credit minimizes the liability of the company, depending on how much the company spent on the R&D.

Are Game Developers Eligible For The R&D Tax Credit Software?

Any business can claim the R&D tax credit as long as they spend on creating and developing new products or improving processes. Any expenses incurred from these activities may qualify for R&D tax credits. Qualifying companies can claim the entire amount they used to spend on eligible activities in a given tax year. If they have unused credit, they can claim it for up to three years.

They can also carry them for twenty years. However, there are requirements they should meet before they reap the rewards. The four-part test below helps identify whether a business is eligible for the tax incentive:

  • Eliminating uncertainty. The intention of performing research must be to reduce technological doubts about developing or improving a product or process. Even if they are unresolvable within a given year, they will still get the tax incentives.
  • Qualified. The activities must establish a deliberate innovation in developing processes or products or improving performance using new methods. They should result in better function, quality, and performance.
  • Elimination process. The activities must follow a structured methodology during analysis, testing, and evaluation to identify technical uncertainty.
  • Technological in nature. The activities must involve technical development, and research must involve hard sciences, such as computer science, physics, engineering, etc.

Also, the company must prove that they have completed the R&D during development and testing. It means the processes must involve using scientific methods and following protocols for testing and analyzing results.

How Game Developers Can Use R&D Tax Credit Software

If a company is eligible for the R&D tax credit, it will have plenty of choices regarding how and when they apply it. For many, the credit will go towards their income tax liabilities. But for startups, most of the amount will help offset the payroll obligations.

Below is a summary of the ways businesses can use R&D tax credits to their advantage:

  1. Earning back up to 15% of funds used on qualifying expenses

The total refund amount will depend on the specifics of the business. But generally, it should cover 5% to 15% of any eligible expenses. It means that if the company has spent $150,000 on research expenses, it will receive about $7,500 to $22,500.

  1. Using the credit to offset payroll obligations

One of the ways small companies use their R&D tax credit is to make up for their payroll taxes. For them to qualify, their gross receipts must not exceed $5 million. Also, they should not have gross receipts from five years ago.

If they meet the requirements, they can use the tax credits to even out up to $250,000 in payroll obligations. The credit will go towards the taxes if they choose this method when filing their income tax returns. And if they qualify for the tax credit multiple years in a row, the surplus value of the credit can go towards the amount they need to pay for their income tax liability.

  1. Going back to move forward

If businesses fail to claim their credit in the previous years and can still qualify, it isn’t too late to go back and make the necessary adjustments. They can update their income tax return to include the R&D tax credit software, allowing them to receive a refund for said year.

Thriving companies that continue to have R&D expenses may feel that they aren’t getting any benefits. But here’s the good thing – companies can carry forward any of the unused parts of the tax credits for up to twenty years.

Calculating The Expenses Used For R&D Tax Credits

Companies must provide documentation of their qualified expenses to calculate the R&D tax credit. These documents may include:

  • Used supplies during the development process
  • Contract research expenses (usually given to a third party when doing qualified research activities)
  • Salaries that went toward the employees who worked, supervised, and supported the development process
  • Expenses for the cloud service providers and leasing computers used for performing research projects.

Research doesn’t have to produce successful results for them to qualify. Businesses could still claim the tax credits even if the project failed.

R&D Tax Credit Software Documentation Is Key

As long as the company properly documents its R&D, innovates, and improves its products and processes for its intellectual property, it can still reduce its tax liability. There may be additional incentives in other states, but generally, there is broad applicability to most video game companies.

By nature, video game development constitutes a lot of technical testing and innovation, so it is well worth considering which expenses you can claim the credit against, thereby minimizing your tax liability. In the end, you could set up your business for continued growth.

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