With a new year comes a new set of tax laws that were passed at the absolute last minute.
While the GOP tax bill isn’t going to affect your 2017 tax returns, just next year’s, I wanted to get this piece out to the indie game developer community early to address some of the most important aspects of the bill most likely to affect us so you can start thinking about 2018 business decisions ASAP. Because like it or not, there’s major externalities that come with tax bills, not the least of which is that tax laws and overall business environments affect our decision-making.
If You Want the 5-Second Movie Version
The good news: Even if your operations are tiny and you’ve got outside sources of income, there are some ways that we actually benefit from this bill.
There are nuances of business taxation that the AAA and “triple-i” sectors of development are more likely to benefit from than the average indie dev, which I’ll gloss over.
I also have some bad news: we lost a couple deductions, some of which may or may not have had an impact on your tax bill in the past depending on the size of your operation.
It’s largely individual personal income tax mandates that got screwed the most. (Remember that bit about tax bills having externalities?) Most of those personal income tax updates are outside the purview of this article, so I’ll leave it like this: you’re totally screwed if you’re a homeowner and got significant property taxes, have a family, moved for a job, or are a performing artist treated as an employee for tax purposes (ie symphony member.)
First, Don’t Panic
There’s a lot of misconceptions and panic about this bill at the time of writing. It passed at the end of the year when you were likely already stressed out with holiday travel, preparing for boothing at MAGFest (2019 is when I will finally go!), plus trying to score last-minute deductions for 2017 all while hearing about all the things you’re going to lose at the personal level. Throw in our trash fire 24/7 news cycle, frenzied discussions on social media, aforementioned holiday and 2017 tax season stress-- it’s a lot to take in.
There’s also a lot of articles still being shared about the initial proposed changes, not the actual final version that passed (and right now, the latter seems to be largely contained to tax professional journals and not mainstream news outfits), so here’s the most important pieces of the bill most likely to affect us that you DON’T need to panic about:
Grad students need not worry. With the amazing game dev programs in schools we have now, there’s many who are getting their foot in the door through a fellowship program or incubator at a school. Or, may be using fellowship funds to work on their first game. At the time of writing, no changes have been made to the treatment of fellowship income (which often has taxable and tax-free portions) but your tuition waiver is safe. And for what it’s worth, so is the student loan interest deduction at the personal level with a phaseout range still applying depending on your income.
The home office deduction isn’t dead. The good news is that while this deduction was saved from the chopping block, you’re still subject to the finer nuances of the home office deduction rules (namely “regular” and “exclusive” use, so be careful with those co-working space memberships and shared offices if you claim this deduction.) You can still elect to take actual expenses or the simplified method of $5/square foot for up to 300 square feet ($1,500) but the regular and exclusive use test still applies.
If you’ve been hearing about the death of business expenses but you have your own studio, you’re likely not one of the affected people. Employee business expenses are dead. Not normal business expenses for contractors, freelancers, studio owners, partners, and the like. If you’re an employee of a game studio and you incur expenses you don’t get reimbursed for (such as travel, meals, plus the home office expense if it was for their convenience and not yours), you used to be able to take a deduction for these expenses if you itemized personal deductions and they exceeded 2% of your adjusted gross income.Certain professions, like performing artists, could take these expenses as an adjustment (a more powerful deduction that reduces your adjusted gross income; student loan interest and half of your self-employment tax are adjustments.) You still can for 2017 but not going forward.
Every indie dev has a unique tax situation, often predicating on your game studio not being your primary income source. This bill disproportionately now puts the tax code in favor of business entities, not wage-earners, and many creative professionals tend to be both.
Since most tax publications are making this bill out to be a big win for small business and freelancers, I wanted to put the above things in the 5 Second Movie version in context.
The Journal of Accountancy gave a pretty thorough rundown of what’s changing, but I’m going to highlight the most pertinent points for us.
Computers Are No Longer Listed Property
Quick thing of note, "listed property" encompasses things with highly personal elements open for loophole abuse, and computers and peripherals were in this category forever. So, write off that new computer station in full: you'll no longer have to take burdensome records to prove that you bought it all or mostly for business.
The Business Entertainment Deduction is Dead
If you’ve got employees, you can still deduct office parties. But if you’re a non-employer of any kind and planned on entertaining teammates or clients whether it’s throwing a party or taking them out to a concert or something, that deduction was killed.
Naturally, they did this right when I planned on throwing the very first Sonic Toad Media GDC party in 2018. (Just putting that out there if you’re looking for a fun GDC party! Follow me on Twitter and/or sign up for my mailing list to stay apprised!)
You can still deduct meals, coffee, bar tabs, and the like connected with traveling for business but not for entertaining clients/prospects/teammates anymore. I was under the impression that you could still deduct catering for GDC parties and other recreation if it's away from home, but you'd need to keep records proving that some part of the catering was for your and/or your teammates' meals while traveling and there'd probably be annoying pro-rating involved. But regardless of if it's a home or away game, you can no longer deduct space rental, decorations, and other direct party-related expenses anymore. (But you can still deduct semi-related expenses like having invitations/e-vites made and paying an event planner to help you put it together.)
So if you’re taking out your investor or teammate for dinner and a movie while you're in their area, only the things that you ordered for dinner will be deductible as a travel expense (and still subject to the 50% limit and substantiation requirements.) You can still treat someone to a meal, drink, etc. and use company funds for it-- this is all part of indie dev and entrepreneurial culture where treating someone is customary and great game ideas are incubated in restaurants with immersive atmospheres or feeling super energized after a thralling escape room or catching an indie film together. But it's unfortunately not going to have a tax benefit anymore.
What the 20% Deduction on Pass-Through Income Spells for Most Indie Devs
95% of all American businesses are pass-throughs, even some mega-businesses like Georgia-Pacific. Pass-through entities are virtually every type of business except C corporations. Given that a majority of indie developers will fall under the income limit for this benefit, it’s definitely worth delving into.
There’s a couple caveats here, so let’s not get too excited about this deduction just yet. Forbes gave a very detailed breakdown of this deduction works after the bill became law but if you want it in game dev-centered English:
There’s an income limit then a phaseout range. Got a high-earning spouse supporting you and/or haven’t quit your job yet? Your total taxable income (not adjusted gross income, unless the interpretation changes later this year) needs to be less than $315,000 if you’re married filing jointly, $157,500 for every other filing status. The phaseout begins at the next $50,000 of taxable income up to a limit, so if you’re a single contract programmer earning that $157,500 from a job but your total taxable income is $207,500 after accounting for game royalties, freelance work, etc. then you don’t get the deduction. It would be less than 20% if it was between $157,500 and $207,500. If you’re married, you still get the full 20% at a combined taxable income of $315,000 and the phaseout would start there until you’re no longer eligible at $365,000.
The “required investment” formula could nullify the deduction out of the gate. Before you freak out about this portion, the first thing you should be aware of is that this ONLY applies to you if your total taxable income falls into that phaseout range I described above. If your income is BELOW those amounts for your filing status, the required investment portion doesn’t apply to you. So, what’s this about required investments? Congress decided to complicate this deduction by tying it to how much you invested in your business. This leaves most indie developers out for two reasons: the formula is based on W-2 wages paid to employees (which we tend to not have), and on the assets invested in your business. Which well...game devs are not a very capital-intensive business in that our dev costs are our biggest investment opposed to vehicles, equipment, and physical plant assets like machinery. In a nutshell, the maximum deduction is 25% of W-2 wages paid plus 2.5% of "qualified business property" which is pretty much whatever assets you've bought and are still using but only stuff that is 10-year property or greater. Most of us have what's known as 5-year property, like computers, peripherals, and other equipment used to make games. 10-year property is for things like furniture and fixtures while commercial buildings are 39-year...which we also don't have! So what do we get with no employees and no qualified property? Zero extra benefits. I told you not to get too excited. But given that the typical indie isn’t raking in mid six figure amounts, you’ll likely be exempt from this.
Knowledge workers operating as solopreneurs (e.g. programmers, consultants) got the middle finger with this on purpose. Any trade or business where the primary product is your skill and/or reputation (so this means my own business is out, same goes for all you gaming attorneys reading this) does NOT qualify for this deduction. The good news? There’s two pieces: similar to the capital formula in the last bullet point, the income limit also gets your out of this so self-employed knowledge workers aren’t *completely* screwed. The second part is that if you DO fall into that phaseout range, while a game studio could rely on your skills and reputation for work-for-hire? It puts you into a gray area as far as qualification is concerned. But if you own your IPs and market them to a fanbase and it's the game itself driving your sales, the game's the product and not your reputation, so this law could be interpreted in your favor. But just so you're aware, if you're funneling consulting and work-for-hire through your game studio to keep the books less complicated, it could be time to start a separate pass-through for this type of income if you make significant enough money to make the upkeep and startup costs worth it.
Your self-employment taxes don’t change. The biggest thorn in just about every game dev’s side, and pretty much for any self-employed person in general, are those frigging self-employment taxes that sneak up on you so fast. Only business expenses can initially reduce them, followed by refundable tax credits, which I detail in my book. So if you qualify for this pass-through business deduction, don’t expect your self-employment tax to change. The base will be the same as it was before, only your income tax rate will be affected.
Corporate Tax Rates and AAA/III
Depending on your personal financial situation, goals as a game dev, and how ownership is split (especially if you have foreign owners) then you may have opted for a C corporation to organize your studio.
The maximum corporate income tax rate (which let’s be honest, is more of a AAA concern) has been permanently cut from 35% to 21% while most of the provisions I described above are sunset provisions (mostly by 2025.)
While the maximum corporate rates might not concern you right now, they can become one if you plan on taking on foreign partners and seeking out investment which is when it’s more appealing to become a C corporation. The bill wants to make it easier to convert your pass-through business to a C corporation to take advantage of the reduced corporate income tax rates (and relief from the onerous wage-and-capital formula to get that 20% deduction, and no income limit) particularly if you want to do so in the next two years.
Net Operating Losses and Indie Developers
Under the old rules, net operating losses (which are common for several years in a row for us) could offset income up to 20 years forward or two years back. But the new tax bill dictates that net operating losses racked up in 2018 and beyond can only be used to offset up to 80% of business net income in any year indefinitely in the future.
Interestingly, this loss also is treated as if it generated interest to preserve the value over time. On one hand, this could work to your advantage if you spend years on dev costs then suddenly have a hit and you offset the royalties completely. But on the other hand, if you're still holding down a job you don't get the tax relief that a net operating loss from your studio used to grant you.
Further guidance is expected to be issued later in the year. I’ll keep the indie dev community posted on any updates on the bill’s interpretation and how it expressly impacts indie developers who have the unique concerns of being both a wage earner (or freelancer) and business owner. Many of the basic tenets outlined in The Definitive Guide to Taxes for Indie Game Developers didn’t drastically change from the initial publication to the end of 2017, but please let me know if the comments if you’d like to see an updated edition for the 2018 tax reform given that many parts will change materially.
(Edited 1/16/18 to clarify non-employer piece as well as the ruling I just saw which now says that you can't even deduct meals out with clients anymore-- only as a travel expense. Really, Congress?)
(Edited again 1/27/18 after the IRS issued yet another clarification, and more are sure to come.)