Video game developers are benefiting from research and development tax credits and recent changes in the rules for deducting R&D expenses, with tax professionals helping claim valuable tax breaks for gaming companies.

“For video game developers, improved cash flow can really translate into additional resources for hiring talent, developing their next product, their next title, accelerating timelines, expanding distribution, whatever the case is,” said Josh Harbin, a senior manager at Top 10 firm Baker Tilly in Sacramento.  “Ultimately the R&D tax credit is not only rewarding the innovation work that’s being done, it’s also fueling and continuing to grow the industry.”

The tax credit provides particular advantages for game developers. “When you look at what qualified research is under this tax definition, the video game industry is uniquely situated at the intersection of both entertainment and technology,” said Harbin. “When you’re developing a new title, a new game, there’s coordination between that artistic, creative aspect as well as the technical, engineering aspect. You have this dual nature, and it’s critical to distinguish the difference between that creative, artistic element, the narrative, visual design, storytelling aspect, from the underlying technical development, the game engine, the algorithms, rendering systems, etc. That’s why from my point of view, this is a unique area for the R&D credit.”

In every game there are new advancements that leverage R&D. “That same kind of mentality is going to come into play for video game developers on whatever title and whatever game they’re creating next,” said Harbin. “They want to create the most immersive experience for their players, and they’re going to continue to innovate on things like ensuring a smooth process, improving frame rates, reducing latency. Are we rendering things the proper way? Those types of activities are continuously being done on everyday development.”

Besides the federal tax credit, many companies can also claim state tax credits for research. “About 40 states have an underlying state credit following the federal definition, so you get a state benefit as well as a federal benefit, and it’s based on whether activities meet a statutory test,” said Todd Sutherland, partner and director of research and development tax credits at Top 50 firm UHY in Houston. “Gamers in today’s world would be largely doing software development through apps or other functionality. Those activities generally are treated as R&D activities, if they’re writing code, algorithms, things like that, if they have software engineers, analysts, the typical agile, waterfall, scrum, sprint type development philosophies. Those types of trades or businesses can also be eligible to earn credits based on those development activities.”

Artificial intelligence

R&D activities can involve various aspects of development in the video game industry. “You could be looking at game engine innovation, proprietary engines, new algorithms, simulators, embedding AI, creating rendering pipelines, etc.,” said Harbin. “You could be looking at ways to make sure your game is approachable on different platforms. Whether you’re looking at consoles or PCs or mobile devices, how the game transitions between different platforms. Something that’s always evergreen within the R&D space for video games is things like performance improvements, rendering latency, improving frame rates, all of that type of activity.”

The development of games for each new gaming platform or console also involves some amount of research. “There’s definitely nuances to each platform that they’re distributing on,” Harbin noted.

Artificial intelligence is increasingly being used in games, including helping to write some of the code and influence how the game is played. 

“AI is obviously a hot topic across every industry at this point,” said Harbin. “Within the video game aspects, embedding it within the game itself is something that can be experimented with, how the game can dynamically shift for a given player using these types of technologies. I would say, generally, we’re probably in the early stages of how AI is going to influence the video game industry, and most industries for that matter.”

Documenting the R&D credit

The IRS has been toughening the rules around documenting R&D activities on Form 6765 to ensure companies are submitting legitimate claims for the tax credits.

“The IRS is heavily focused on documentation right now,” said Harbin. “Anytime you claim an R&D credit annually, it’s on Form 6765 or whatever applicable state form. There’s generally three main areas that you’d be looking at for an R&D credit. You’d be looking at what that qualified research activity is, understanding the costs associated with those activities and then computing the credit. The key at each one of these steps is documentation, for example, clearly illustrating how a particular project is considered qualified research under this tax definition, and providing that contemporaneous documentation to support it. And this is what we’re seeing heavily scrutinized on IRS exams and in recent case law as well, the biggest issue being the lack of that substantiation.”

He advises companies to be careful about documenting the R&D they do. “The biggest advice I could give would be around documentation, understanding what needs to be documented and how best it can be documented, really illustrating that the work you’re doing meets the IRS definition of qualified research and providing that,” said Harbin. “A lot of times, companies are creating documentation during their general product development lifecycles. Making sure they retain those documents for this purpose, and documenting even more is always helpful, really illustrating the point that what we’re doing is innovative activity. It’s going to go a long way.” 

While he hasn’t seen instances where the IRS challenged the R&D tax credits claimed by video game developers, it can be a problem in other types of companies. “In general, that is a big sticking point for the IRS currently across the industries, not just in video game development, but documentation is definitely something that the IRS is focused on, something that they are pointing to when they deny credits,” said Harbin.

Even with the staffing cuts at the IRS this year, especially on the enforcement side, companies and their tax professionals still need to be careful that the claims are correctly documented. “The staffing changes, aside from just R&D credits, have been impactful for different IRS exams,” said Harbin. “Some cases have been closed sooner than we thought they might have been, but we do still see audits for R&D tax credits popping up, and that’s why it’s still important to have this documentation in place for taking advantage of these credits.”

R&E expensing changes

Besides claiming the R&D tax credit, many companies are expected to take advantage of a provision in the recently passed One Big Beautiful Bill Act restoring the ability to deduct research and experimentation expenses in the first year under Section 174 of the Tax Code rather than amortizing them over five years under the Tax Cuts and Jobs Act.

“There’s two different tax concepts when we talk about R&D,” said Harbin. “One is the R&D credit under Section 41 of the Code. The other is the research and experimentation expenditure deduction, basically Section 174 of the Code. What’s making news recently is Section 174 and that’s because from 2022 to 2024 there’s a significant shift in policy in how these costs were being treated for tax purposes. Your domestic R&E or 174 costs were required to be capitalized and amortized over a five-year period, rather than the previous policy, which was being able to fully deduct those costs in a given tax year. For foreign costs, it was a 15-year amortization period. Now, with the new bill, the One Big Beautiful Bill Act, starting in the 2025 tax year, companies once again have the option to fully deduct their domestic 174 R&E costs. Foreign costs would still have to be capitalized over that 15-year period. And further — which can come into play for video game developers — certain small businesses do have an opportunity to retroactively apply these rules to the 2022 to 2024 timeframe through various elections and method changes.”

He pointed out that there are different ways to do a retroactive application. “It could be something you’re doing on your 2024 tax return right now, but it could be something that you address in the near term before July 6, 2026, but yes you do have opportunities on the tax returns that are likely in process right now,” said Harbin.

Industry investment

Other industries besides the gaming industry will be benefiting from claiming R&D credits and faster expensing of costs. The Trump administration especially wants to incentivize companies to do business in the U.S.

“The government doesn’t release data on taxpayers that are recognizing 174 costs,” said Sutherland. “They do, however, release very old data on sectors that are claiming the credit. The two sectors that claim most of the credits are the manufacturing sector and professional, scientific and technical services sector. The manufacturing sector takes 40% of all R&D credit claims. The good news at the end of this, outside of the accounting challenges, is companies can have confidence in investing in domestic R&D again. They can get credits, generally speaking. On top of it, these credits are intended to be job creators and encouraged to reinvest the cash from the credits back into the industry. And frankly, it’s trying to encourage more onshore R&D.”

He noted that the OBBBA did not change the amortization requirements for foreign companies. 

“Foreign R&D expenses were not altered,” said Sutherland. “You still have to amortize foreign R&D costs over 15 years. For gamers, a lot of software development is offshore, and that’s been a real challenge for companies to recognize that they’ve got to amortize those costs for 15 years, and they don’t get credit on them. This administration and Congress always wants to create a strong R&D incentive.” 

However, he believes it will help make the U.S. more competitive compared to other countries that are members of the Organization for Economic Cooperation and Development in terms of the strength of its R&D incentives. 

Harbin sees benefits for game developers from use of the tax incentives. “The R&D credit can significantly improve cash flow for game development studios who really need cash to hire talent to create the games,” he said. “It’s a unique blend of artistic creativity, as well as technological advancement. Recognizing this mix is important when it comes to R&D tax credits, and really documenting the difference between the two and making sure that the computations are done appropriately. That’s one of the reasons I’m passionate about working with different studios to navigate this process and helping them along the way so that they continue to create innovative games.”