Even if no one at your company wears a lab coat, you shouldn’t rule out your eligibility for the Research and Development (R&D) tax credit, a credit that allows a taxpayer a nonrefundable income tax credit for certain qualified research expenses. When it comes to the Research and Development tax credit, software innovation is often overlooked as a qualifying activity, but it has the potential to provide great benefit to your company. If your business has developed software for internal use, you could qualify for saving money on your taxes through R&D.
Many activities that are geared toward making enhancements to a business can qualify for the R&D tax credit, including improvements to products and processes. The R&D tax credit rewards activities aimed at creating new or improved products and functionality for a business that are technological in nature. Other IRS stipulations for receiving the R&D tax credit require substantially all of the qualified activities to involve technical uncertainty and a process of experimentation. All of these can be central to software development.
In light of recent updates, now is a great time for taxpayers to review whether they are eligible for research credits regarding software development. In 2016, the U.S. Treasury issued final regulations that changed the requirements for software that was eligible for the R&D tax credit. Prior to these regulations, software that was not sold, leased or licensed to a third party was considered internal use software. Previously, there was additional qualifying criteria for internal use software that prevented many taxpayers from claiming a credit for this software development.
Under the new regulations, software development that enables a company to interact with a third party (customer/vendor) is excluded from the definition of internal use software, and, therefore, it is not subject to the additional qualifying criteria. Only development activities relating to financial management, human resource management and back office support activities are considered internal use software, making it easier for companies to qualify for the R&D tax credit.
Types of software not considered internal use (not subject to additional criteria) include those that:
• Enable a business to interact with third party;
• Allow third parties to initiate functions or review data on a business’s system;
• Are “hosted” or developed, but no copy of the software is transferred; or
• Are developed for use in a production process and meet the requirements for qualified research.
Start Saving on Your Taxes
If your company develops software, whether off the shelf or cloud based, or you have developed software to communicate with third parties, now is a good time to investigate whether or not you are eligible for a tax credit and start documenting your project.
Software innovation is just one area that could qualify your business to take advantage of the R&D tax credit. The Research and Development tax credit offers a financial incentive to other types of innovation as well. If you have attempted to improve other products or processes within your company and if those projects meet certain criteria set forth by the IRS, those activities may qualify your business to utilize the R&D tax credit. Even apart from the Research and Development tax credit, the federal government offers many different tax credits and incentives to companies for other activities that your business may already be doing.
If you want to learn more about the R&D tax credit and other ways that your business may be able to save money by utilizing tax credits and incentives, Warren Averett can help. Our Firm’s diagnostic tool, Quali-Finder, was developed by knowledgeable tax experts to help businesses identify areas of tax savings that they may be overlooking.