The R&D Tax Credit

Why This is A Great Time to Invest in Software for your Business

There is an underutilized tax advantage out there called the Research and Development (R&D) Tax Credit. The IRS estimates that only 10% of companies that qualify for the credit take advantage of its benefits. However, any company that develops, designs or improves products, processes, formulas, techniques, inventions or software can be eligible for the credit. Typically, small companies overlook research and development because they do not have an R&D department, lab or scientists. Research and development can come from engineers, software developers, factory workers and a variety of tasks performed in daily business.

The exciting news in the Softwerks office is that effective October 4, 2016 the IRS has expanded the regulation to include the creation of Internal Use Software (IUS). Previously, the R&D Tax Credit was only offered to companies working to develop software for other companies to use.

The R&D credit is an actual dollar-for-dollar credit against taxes owed or taxes paid. That’s an important distinction that is often overlooked. A tax deduction is something that reduces how much taxable income you claim. A tax credit is something that directly reduces how much tax you owe.

While Uncle Sam wants to encourage you to take risks in innovation, there is criteria your project must meet to qualify for the R&D Tax Credit – and there’s a few extra for IUS to be judged upon. However, the criteria aren’t as stringent as it might seem at first glance.
Reference these four parts to determine if a project is a qualified R&D activity:
  • Qualified research activities are defined as, "the development or improvement of a business component (defined as a process, technique, product, invention, formula or software)."
  • The research must be technological in nature and must rely on the physical or biological sciences, engineering or computer sciences.
  • The research must be intended to eliminate uncertainty in the development or improvement of the business component.
  • Elimination of technical uncertainty must be accomplished through a process of experimentation, including trial and error, simulation or modeling. Failure before success in the research is not a requirement in this area.
In addition to the 4 part test described above, IUS must also meet the following “High Threshold of Innovation Test”:
  • Software is innovative- If the development is or would’ve been successful, and will/would’ve resulted in a substantial drop in cost or improvement in other performance metrics, it is considered innovative, and therefore the credit still applies.
  • Involved major economic risk- If the taxpayer uses substantial resources for the development and there’s doubt whether resources used will be regained within a reasonable period (because of the technical risk involved in the development), the credit still applies.
  • The software is not commercially available- If the taxpayer is not able to buy, lease, or license purchased software without considerable modification and expense, the credit would still apply.
Of course, here at Softwerks we are software creationists, not accountants – so we strongly encourage you to reach out to your accounting professionals for advice on how to proceed and capture the gains associated with the R&D Tax Credit. Then give us a call when you’re ready to use it to your advantage to make all your business process improvement dreams come true.

"The ladder of success is best climbed by stepping on the rungs of opportunity." -Ayn Rand