Unbeknownst to many technology firms and video game developers, the state of Louisiana offers some of the most advantageous credits and incentives for small companies. Perhaps the best-kept secret is the Louisiana Research & Development Tax Credit, which is undoubtedly the best incentive offered for R&D by any state.
How is this incentive so valuable?
In 2009, Gov. Jindal signed into law two major enhancements to the state’s R&D Credit: (1) an increase in the size of credits available to small businesses, and (2) a change in the character of the credit, from a “transferable” credit to a fully-refundable credit. As a “refundable” credit, taxpayers may receive a refund over and above any Louisiana or Franchise tax liability they may have incurred, even if they incurred no tax at all for a given year.
To measure the magnitude of this incentive, consider that the Research & Development Tax Credit available at the Federal Credit typically equals 6% - 10% of a taxpayer’s qualified research expenses for a given year and can only be utilized in that year if the taxpayer incurred a tax liability (unused credits may be carried back & carried forward). For a company with less than 50 Louisiana employees, the State offers a credit equal to 40% of the taxpayer’s qualified research expenses that is fully refundable – even if the taxpayer incurred no state income or franchise tax liability, they will recover the full cash value of the credit in that year. That means a company with $100,000 in qualified research expenditures will receive a refund of up to $40,000.
How do technology companies qualify?
There are two main elements to any R&D Credit claim – qualified research activities, or QRAs, and qualified research expenses, or QREs. Louisiana follows the definitions for “qualified research” contained in Internal Revenue Code 41, which governs the Federal Research & Development Credit. IRC 41 lays out a four-part definition for qualified research:
Business Component / Permitted Purpose - This initial test requires that the goal of the activity is to improve the quality, functionality, durability, or performance of a business component. The IRS defines a "business component" as any product, process, computer software, technique, formula, or invention. For video game developers, development of new software components for games, such as a new or improved game and graphics engine, new or enhanced artificial intelligence, new player interaction schema, and new game tools will meet the Business Component / Permitted Purpose test.
Technological in Nature – The second test requires that a qualifying research and development activity fundamentally relies on the principles of physics, biology, chemistry, mathematics, and computer science, essentially the “hard sciences.” Video game developers fulfill this requirement because they employ principles of computer science, engineering and other “hard sciences” as they design and improve their games.
Uncertainty – The third test requires the research and development activities have an associated level of uncertainty related to the development or improvement of a product. There must be uncertainty as to the taxpayer’s capability of creating or improving the business component, the taxpayer’s methodology for doing so, or there must be uncertainty as to the final outcome or design of the new or improved business component. Certainly, a video game designer encounters uncertainty at every turn, from how to program certain functionalities into their games to determining whether it is even possible to do so.
Process of Experimentation – The final test is whether a taxpayer can demonstrate a process of experimentation that was undertaken to resolve the uncertainty issues. In this last test, the company must incorporate a process of experimentation designed to evaluate one or more design alternatives. Video game designers and software developers by nature undertake a process of experimentation as they create their games and software. Rarely, if ever, does a video game developer arrive at a finished product without a great deal of evaluation and experimentation.
Assuming that the individual activity or project qualifies under the 4 part test, a taxpayer must then allocate QREs for the project. There are three categories of QRE’s:
Wages- The most significant portion of an R&D Tax Credit claim for most technology-based companies is found in employee wages. Wages are generally defined as compensation subject to withholding for employees for engaging in, directly supervising, or supporting qualified research. In smaller companies, the owners sometimes compensate themselves with guaranteed payments, bonuses, and other types of compensation. As long as those payments are subject to withholding, and the owners are engaging in qualified activities, those amounts may be included in the credit calculation.
Contractor expenses- The second type of allocable R&D costs is contract research. A taxpayer may allocate 65% of contract research done by third parties as long as the taxpayer was required to make payment to the contractor regardless of whether the research was successful, and the taxpayer retains intellectual property rights to the research. For the Louisiana R&D Credit, the contract research activity must take place in Louisiana, although the contractor need not be a Louisiana company. For example, a video game developer who uses a Georgia-based programmer could allocate costs if the programming work is being performed in Louisiana.
Supply Costs- The second type of allowable R&D costs is supplies. Supplies are defined as any tangible property other than land or improvements and property subject to depreciation. Generally, video game designers and software developers are not able to allocate supply costs, since the supplies generally must be consumed in the creation or improvement of the business component. For example, hardware purchases would generally not qualify as a supply cost for purposes of the R&D Credit.
In addition to the Louisiana state R&D Tax Credit, there is a Federal Research and Development Tax Credit that generally equals 6 to 10% of qualified research expenditures. Although the Credit is not refundable, it can be of benefit to companies who are paying federal tax. Even for companies who do not have any current federal tax liability, the Federal Credit may be carried back one year and carried forward for up to 20 years.
In sum, Louisiana video game programmers have an excellent opportunity to claim the Research and Development Tax Credit. The significant refunds that the Louisiana Credit offers can power even more innovation and creation of products, which will lead to more and better paying jobs and foster a hospitable climate for innovation within Louisiana.
TRCG Advisors is a leading tax advisory firm specializing assisting companies and their CPA’s in capturing and supporting federal and state tax credits and incentives, including the Research and Development Tax Credit. Adam Weems, founding partner and Managing Director of TRCG Advisors, earned his B.A. from LSU and his law degree from Loyola University in New Orleans. For more information, call Adam at (225) 336-8000 or email at email@example.com.