R&D Tax Credits for Internally Developed Software?

Tax,Technology and Security
R&D Tax Credits Checklist

R&D Tax Credits for Internally Developed Software?

IRS regulations finalized a few years ago make it easier for some companies to claim R&D tax credits for software they develop for internal use. Generally, the credit is not available for “internal-use software” — software developed for use in general and administrative functions that facilitate or support conduct of a company’s business — unless the company meets a high-threshold-of-innovation test (in addition to the other requirements for the credit).

The regulations expand the types of software eligible for the credit (without meeting the high-threshold-of-innovation test) by providing a narrow definition of general and administrative functions. These functions are limited to financial management, human resource management, and support services functions. The regulations also clarify that software is not developed primarily for internal use if it’s developed:

  • To be commercially sold, leased, licensed, or otherwise marketed to third parties, or
  • To enable a company to interact with third parties or allow third parties to initiate functions or review data on the company’s system.

The second bullet point clarifies an issue not addressed by previous regulations: Software that customers access over the Internet to do business with a company is treated as third-party-facing software and, therefore, is not internal-use software.

Otherwise excluded internal-use software qualifies for the R&D credit if it meets the high-threshold-of-innovation test. Under that test, in addition to meeting the usual requirements for qualified research, the software developed must be highly innovative, unavailable commercially, and involve significant economic risk.

If your company develops software for internal use, contact us to be sure you’re getting all of the R&D credit you deserve.

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