The qualifications for inclusion within the Research and Development Tax Credit (R&D) has been a source of arguments for taxpayers and the IRS since the enactment within the Economic Recovery Tax Act back in 1981. Particularly contentious have been the costs for the internal-use software. In January of 2015, the IRS released new proposed regulations to help provide clear rules regarding R&D with regard to internal use software.
The federal R&D tax credit is governed by Sec. 41 and its regulations. To begin the defining process of what qualifies as internal use software, all qualified expenditures must begin by passing a four-stage test to be deemed as qualified QREs and remain eligible to receive the credit. These four steps include determining:
While external-use software meets only this four-part test, any internal-use software must also pass a three step “high threshold of innovation” test:
2015 proposed regulations also limit the definition of internal-use software by more clearly stating what is not internal use software. These proposed regulations define the following as non-internal use software:
Since the R&D tax credit began, it has provided a tremendous amount of benefit to taxpayers who incur and invest in domestic research expenses. While this tax is not currently a part of the permanent tax laws, it has been continuously extended as a part of the Tax Increase Prevention Act. Many taxpayers taking advantage of the benefit year after year are hopeful to see it become part of the permanent tax code at some point in the future.
If you are uncertain about how to navigate the evolving world of R&D tax credits and internal use software requirements, please contact us today to see how we can use our experienced team of tax consultants to help ensure you receive your credit.