Cryptocurrencies and related digital assets such as non-fungible tokens (NFTs) and crypto coins make the news for minting millionaires, fluctuating prices, and stories of millions lost to malfeasance or market implosions. Blockchain, the underlying technology, is less frequently discussed.
Companies using blockchain technology to solve problems in a range of industries may be eligible for tax credits designed to encourage technological innovation. Credits include the R&D tax credit intended to boost research, as well as credits for start-up companies that began operation in February 2020 or later.
Blockchain technology, which relies on distributed ledger systems and consensus protocols to track ownership and exchange of digital assets, has many applications. For example, the Ethereum blockchain can perform automated contract execution and decentralized voting mechanisms.
While public gaze might focus on the latest upheaval, industry innovators continue to envision a future where blockchain technology solves a variety of problems.
What Is Decentralized Finance?
Decentralized finance, or DeFi, relies on cryptocurrency as an alternate form of currency for the exchange of goods and services. Traditional finance has become dominated by a large group of commercial banks and transaction processors using network effects and economies of scale.
The major players in these industries can control the flow of funds between businesses and consumers and extract fees that might seem out of proportion to the value provided by the intermediaries.
Some start-ups envision using blockchain technology to offer a peer-to-peer method of executing transactions and passing the savings on to consumers. The hope is that by cutting out the middleman, transaction costs will be reduced, freeing more capital for investment and consumption.
What Is Web3?
Web3 is a new iteration of the internet in which ownership of digital content is tracked, giving content owners and creators the ability to exchange use of digital data for money.
Currently, when digital assets such as photographs, videos, or other intangible assets are published or transferred via the web, centralized gatekeepers, including major social media platforms, control the flow of access to the information, and the creator’s ability to monetize the asset is compromised.
Some blockchain enthusiasts envision original ownership of digital data stored immutably in a blockchain, with the creators controlling storage, access, and monetization. For example, the original creator of an artwork could be paid a percentage of subsequent sales. Some Web3 proponents have proposed extending this model to tangible property, so that title to tangible property is also conveyed via blockchain.
This decentralized version of the web is in opposition to consolidation of control over user data.
What Are NFTs?
NFTs are digital tokens that demonstrate unique ownership of digital assets.
A variety of platforms, such as OpenSea, have sprung up to enable exchange of popular NFTs like digital artwork. But NFTs aren’t constrained to artwork ownership and over time more companies will identify optimal uses for this technology.
Blockchain Technology for Gaming
As mobile devices have grown in popularity, the gaming industry has deployed games across various platforms, including iOS and Android. Many games are free to play, but certain upgrades and in-game assets including costumes, weapons, characters, and additional levels can be purchased.
Because in-game assets are generally inexpensive, blockchain-based models are increasingly used in monetizing in-game assets, simplifying the process of recording and transferring ownership of in-game assets.
Democratizing the process of purchasing game assets could drive growth in this space. Gaming start-ups building APIs and platforms to use blockchain technology to interact with other blockchain-based platforms have expanded to mobile gaming platforms.
What Tax Credits Are Available for Blockchain Developers?
The R&D tax credit and the recovery start-up credit are available to innovators creating platforms and tools that use blockchain features such as decentralization, flexibility, and public trust verification mechanisms to create use cases.
The US and many state governments support the development of blockchain-based applications by providing R&D tax credits.
Section 41 of the Internal Revenue Code (IRC) provides companies using technology to resolve design, method, and capability uncertainties with tax incentives to offset qualified research expenses (QREs).
What Are Qualified Research Expenses?
Amounts paid for salaries, supplies, contract research, computer leasing, and cloud computing costs could all qualify for the R&D tax credit. Salaries paid to employees who conduct qualified activities are generally one of the largest components in an R&D tax credit claim.
To claim the R&D credit, taxpayers must evaluate and document research activities contemporaneously to establish expenses paid for each qualified research activity.
Recovery Start-up Employee Retention Credit
The recovery start-up credit provides a payroll tax credit of less than $100,000 for recent start-ups. This credit may be used in conjunction with a payroll tax credit election of up to $500,000 annually to offset cost incurred for R&D involving blockchain technology. The credit applies to companies that began operations in technology or other industries.
A recovery start-up business generally is an employer that meets the following criteria:
- Started operating after February 15, 2020
- Has average annual gross receipts of less than or equal to $1 million
We’re Here to Help
To learn more about how federal and state tax incentives can help get your innovative use of blockchain to the market faster, contact your Moss Adams professional.
You can also submit a R&D tax credit benefits estimate request form, or visit our R&D Tax Credit Services for additional resources.