Research Credit Category
That’s a great question, and there is no easy answer. This may clarify it a little:
As individual taxpayers Romney and Buffet pay so little in taxes because of two sources of income:
- They take qualified dividends from their corporations that they own or are investors in.
- They take Capital Gains distributions from investments they have created
For qualified dividends, between 2001 and 2012 they were taxed at 15% (now its 20%), regardless of what tax bracket you were in. Although it seems like a relatively small amount of tax, before any shareholder is able to receive and pay tax on those dividends, the corporation had to pay a tax on that as well (somewhere in the ballpark of 35-40% usually). This is where double taxation occurs. If the company is a foreign company, lets use the Netherlands as an example, they only charge 3-4% taxes on that income, then it gets distributed to Mr Buffet, and he only pays 15%. Heck of a deal.
For capital gains, the maximum rate from 2001-2012 was 15% (now its 23.8%). For investments in a “small business” (a company that has less than 50 million in assets), sale of any stock provides a tax deduction of 50% of that sale, this means that sale is now only taxed at 7.5%… wow. This is why there are so many venture capital firms.
In addition to this, they can also take advantage of investments made in countries with favorable tax laws. Both store a good chunk of their money in overseas, tax favorable bank accounts and investments. Though a slipperly slope for US tax law, many ultra rich investors have many advisors that make it legal. To explain fully would require a whole other blog post.
So as you can see, using those two methods, Buffet and Romney were able to keep their upper tax limit to around 15%, then using deductions, like donations, property taxes, etc, they dropped their tax rates to around 11-12%.
That is only for their individual rates, below is how they win with their corporations:
Huge corporations use a combination of tactics to keep tax low, but the latest and greatest is setting up shop overseas in a “tax haven” country. For example, Ireland made a deal with apple so that they would only charge 3% in taxes on ALL of their worldwide appstore sales. That’s almost a billion dollars in sales a year that they only pay 3% tax on. In comparison, the US would charge 35%.
The research and development credit allows for a very good option too. An example of the extraordinary benefits of the R&S Credit includes the fact that Boeing reported a $20 billion dollar pre-tax income, yet they received a refund from the government of $110 million. Also the new Domestic Production Activity deduction allows a very large deductions as well, most US based companies can access that.
I’ve researched this stuff a lot, mainly because I want to be in the business of offering these options to small businesses and startups, as well as people who may not be as wealthy as Mitt Romney.
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So many new game devs have asked me, and have had concerns over how much my services cost them. I don’t blame them, they are trying to save as much as possible right now, every dime of their existence is going into this project that they have been working on. This article would apply to the start-ups, that really need to start accounting for their income.
I don’t blame them for asking, there are so many unethical shysters out there that are willing to take all of your money with the promise of “massive” money savings. Other CPAs provide services, but offer no insight into how you should manage your financials. Having a “CFO” level of services on your side is very important in this new world of game development and tech start-ups.
My views on the traditional CPA are very pessimistic too, in that most CPAs offer very little to their clients. I will have to write more about this in a future post.
To the point of the post: My fees are very simple.
I don’t charge for advice if you are my client. period.
I charge when Credits and Deductions are analyzed and utilized. I do this because my expertise reflects that these credits would have never been used, and could never have been used unless my analysis was done. I typically charge a percentage of the credit or deductions used, so in other words after you take advantage of the credit, and have money in your pocket, I charge a percentage of that.
I charge $300-500 to set up a Corporation or LLC depending on the state; I find that this is completely reasonable, as most online services are the same if not more (and most charge a yearly fee). I also find that an S-corp or LLC is all that a video game dev needs, and it is VERY important they set this up for future tax purposes.
I charge $200 per hour on corporate tax returns and/or bookkeeping services for the company. This depends primarily on how complex the tax return/bookkeeping is. I always wish that I could nail down a number for people, but I see everything under the sun.
THE BOTTOM LINE – you will be saving much more money than you are spending in fees. That is my policy, at the end of the day, I don’t feel accomplished unless this is achieved. I can find so many deductions, incentives, business advice by being involved in your company that you will save so much more than you spend. Many clients see results immediately.
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And if your CPA says otherwise, fire them. I have seen two articles already where a Kickstarter video game project says they had to pay taxes on their left over money in their first year, this makes me sad, because you can easily avoid that.
NOTE: There has been some confusion on this article where people seem to think I am suggesting you avoid or evade taxes. That is NOT the case at all. These methods used are 100% legal ways to reduce or postpone taxes paid. I want to be very clear: ALL OF THESE METHODS are 100% legal and are in no way avoiding or evading taxes.
In order to eliminate taxes all together there is a simple accounting rule and election of income that you can use, if that fail (which it wont 99% of the time), then there are a few more complex methods that can not only reduce the tax, but can set yourself up to have a tax benefit to carry over to future years, and should probably be used regardless of your situation.
I will start with the first and most simple method:
Accrual accounting is an election that is made on a tax return that allows you to claim income when it is earned, rather than when it is received. This means that every video game company (or many others) out there who get Kickstarter funds would not have to pay taxes on those advanced payments until the game is actually made and distributed to those individuals who pre-purchased it.
Going further, let’s just assume that you have given away items such as T-shirts, artwork, and prizes that you distribute to your backers the first year. You would have to include in income up to cost (or fair market value) of those items on your tax return, because technically you did provide a portion of the service and some of that income was technically “earned”. Therefore, you will be responsible for some of the income earned. What’s important to note, is that you will easily be able to offset that income “earned” with the first year’s expenses or the cost of those items (t-shirts, art, etc.).
Simply electing the accrual accounting system is not enough in itself (which anyone can do including individuals, LLCs, Corps), the IRS still requires a special election to classify the income. If that election is not made, the income falls under the rules set in publication 538 (passage in quotes below) and you do not get any benefit from the accrual election, further, you must use the instructions in pub 538 to properly elect the classification on your tax return in order to make that income an “advanced payment”:
“You report an amount in your gross income on the earliest of the following dates.
- *When you receive payment.
- When the income amount is due to you.
- When you earn the income.
- When title has passed.”
It is important to properly elect to classify this income. I highly recommend a professional handle this for you, as it is easy for someone untrained in taxes to make a mistake with this election. The key to this is to talk to many professionals and ask them if they understand these concepts, as I have seen over and over, most professional do not.
Other Tax Savings Tactics:
Research and Development tax credit
This one I write about all the time, and if you are a video game dev and your accountant has not offered this to you, fire them right now, the benefits are tremendous and could potentially eliminate taxes on income generated from both Kickstarter and sales to the general public. The credit requires some heavy analysis. My firm and many others will not charge until the benefit is used, so it makes complete sense for you to utilize it.
Domestic Production Activity Deduction
This deduction was created in 2004 and was meant to be geared toward the manufacturing industry, then the attorneys over at Electronic Arts successfully lobbied congress and extended it to software and video games. This deduction is 9% of net income, which is an incredible tax break that nearly nobody knows about. For someone that has a net income of $100,000 can easily write off $9,000 as an additional deduction, potentially getting up to $3,000 back in taxes. There are many other requirements to elect this deductions, so again, I advise you to consult a professional with experience utilizing this deduction, not all of them have this skill.
Updated 4/19/2013 with additional information, fleshing out the concepts
Again, this article is only meant as informational, many individuals and companies have unique situations, I recommend you consult a professional before applying any of the above information.
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This article says it all. EA taking advantage of the exact tax incentives that I offer analysis for.
It doesn’t take a team of accountants to save money in taxes
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Video game devs have it good when it comes to taxes, a properly set up system in place could save them thousands and sometimes let them pay as little as 1-2% in taxes. With the basics in place, the Research and Development tax credit, and the domestic production deduction can put that nail in the coffin to nearly eliminate any tax burden once the game is released. Not only that, but many states offer their own Research Credit AND Enterprise Zone Credits (I count those as one).
Results truly vary based on the developer because of the use of their expenses. But the bottom line is that 100% of indie devs can take advantage of at least one type of incentive.
In my experience, Sadly, very few use a professional when they start due to the initial costs. Though spending a few hundred may be the smart thing to do because the last thing they want is to be stuck with a 3 million dollar tax bill that Markus Persson got from his little project called Minecraft (Although Sweden’s taxes are a bit higher than they are here).
A smart company would not only set up a corporation or LLC and pay themselves and their employees salaries, but they would also utilize the R&D credit for every year of development. The dollar for dollar tax credit allows the company to carry forward the credit they utilize each year of production and eventually use the credit to offset their net profits once the game is being sold.
Not only are these credits available to all video game devs, they also have access to a little known deduction called the domestic production deduction. This allows video game devs to deduct up to 9% of income earned from production activities that occur here in the US.
Enterprise Zone Credits
Now, this doesnt apply to everyone, but many states, including CA, NY, SC and FL (among some others), offer an EZ credit. This is a very complex credit, but can save a company thousands in taxes.
The combination of good accounting practices and sound use of tax credits can literally eliminate tax liability from sales of video games. I have worked with many companies virtually eliminating their liabilities using these techniques
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This post is more informative if someone reading this actually looking into doing the Research Credit.
We charge on a contingency basis, in fact, a great many firms do this. If you get a refund from the work that we do, then we get paid. Simple as that.
The reason you will rarely find anyone charging an hourly rate for the Research Credit is that the scope of the credit is so considerable, that it could potentially outweigh the actual credits earned. There are certainly cases where we lose money by not properly qualifying a client before going into it.
Also, the job costing for creating hours billed for R&D credit work can be an absolute nightmare, not many companies are willing to do this, it also creates a burden on the company receiving the credit because they need to review the hours before paying.
Some of you might be thinking, what happens if you inflate the total credit numbers, just to get a few more bucks? There is a sort of insurance, or guarantee attached to the service. If the IRS audits you, then we pay back the difference in fees. In this case it makes sense to create a rock solid defense so this never happens.
Many people ask me when I bring up research credits, why their CPA isnt currently doing it for them if, according to me, they would qualify for such a fantastic credit.
There are many reasons that your typical tax filing CPA wouldnt work on the R&D Credit for you. One of the biggest is that they could potentially lose their license (explained below). Below is a list of some of the reasons your tax CPA is not even offering this type of service:
1. It takes a extraordinary amount of time
Your CPA is already spending a lot of time preparing your tax returns, to add an additional 40+ hours to determine if you have even the slightest chance to achieve the Research Tax incentive is not something that they would do. The only time I have seen a CPA firm offer both Tax Prep and Research incentives, is when it is a top 4 firm, that has seperate departments. This of course shows in the hefty price tag.
2. Its a pain in the ***
The R&D Credit is a very difficulty credit, with literally hundreds of lines of tax code to support it. It is highly specialized, and only certain tax firms that have done the work to learn the ins and outs of the credit can offer the service.
3. Your CPA can potentially lose his license
This is the big one. The Research credit is not an easy credit to perform, it takes hours upon hours of substantiation, your typical tax accountant will have to charge for these services. No one in their right mind will pay an hourly charge for something like this, because if they did there would be a potential situation for a huge bill and nearly zero credits used (in the case that the CPA could not find enough credits to offset the fees). There is enough uncertainty that the credit might not heed results to cause this.
So CPA firms typically charge a contingency, if they can find enough credits to use, they will charge you a percentage of what you use. It makes sense to use this business model, you pay for what you use, and it doesn’t come out of your pocket until money goes into it. I have yet to meet a CPA that charges hourly for tax incentive work.
In this case of charging a contingency, if your tax accountant is preparing your returns as well, they face a very large liability of losing their license if they make any mistake on your return. It is very easy for a CPA to deflate an expense in order to inflate the amount of the tax credit used. This in turn will inflate their contingency collected.
This is illegal under the AICPA. An accountant preparing taxes is not allowed to collect a contingency for it. Period.
Simple enough right? Well maybe not, but there is the long explanation of why your Tax CPA will not, and has not done your R&D credit project. This is why many CPAs work with other firms to provide these services.
I work with 10 other firms and provide their clients with this service. It benefits everyone.
Many start-ups are in one mode only and thats survival mode. Doing what they do best, selling, programming, and creating.
What they fail to do is plan for the future by getting good professional help with their taxes. Just getting a CPA is not what I am talking about.
Finding a CPA firm that can provide all the resources you need is difficult. What I am talking about is providing tax advice throughout the year, doing or auditing books to make sure your financials are sound, and the most important: making sure you qualify for and implement tax incentives.
This is a huge deal when it comes to start-ups, because many do not take advantage of the credits or wait too long and cant utilize the credits from earlier years. Just because you pay little or no taxes now, does not mean you cant use them or benefit from them in the future. A little planning can save you thousands off income you earn in future years.
What I am specifically referring to is the Research and Development Tax Credit (or R&D credit). This credit has been put in place for anyone who spends money to create or improve a product or service. This allows them to lower their taxes and offset some of the uncertaintanty of doing those activities. The credit has been around for years, and is said to provide an incentive for american companies to spend money on creating something, giving us a huge advantage in the world marketplace.
I’ve found in my experience, very few small start-ups utilize the credit, although based on the credit itself, it’s those small businesses that benefit the most.
For a typical startup, the credit is usually around 10-20% of research expenses for the first 5 years, which can be astronomical. You can carry forward the credit up to 20 years, which means if you dont use it right away, you can save it for later. The look-back is 3 years max, so the credit can be utilized in past years if not taken advantage of immediately upon start-up.
Here is a simple calculation showing the potential of the credit itself, these are the assumptions:
- You hire one employee to work on coding software, their salary is $70,000
- You also hire one contract worker (within the US) to debug at $38,500
- You buy computer equipment and a server for $3,000
- You also hire an assistant to help out your programmer and you, the assistant actually helps the programmer 50% of the time, their salary for the year was $4000.
Add those up:
- +25,000 (65% of $38,500)
- +2,000 (50% of $4,000)
- =$100,000 for 1 year
Assume your company’s revenue was less than $500,000 that year.
The credit would be:
- =$10,000 – Off federal and most* state tax liabilities