Does your company use internal software to increase operations or sales efficacy? Great news! You might be able to claim it when you file your taxes under the Research and Development (R&D) Tax Credit. In early 2015, the IRS released a new set of regulations that determine what qualifies as internal-use software for R&D Tax Credit filing purposes.
The regulations state that the software needs to first pass the IRS Four-Part Test to deem the activity a Qualified Research Expense (QRE). The IRS Four-Part Test includes
- The research needs to be technological in nature.
- The invention of a new or improved product or process is conducted for a permitted purpose.
- The invention was created with the intention to eliminate uncertainty.
- The invention went through a process of experimentation. There was an evaluation of more than one alternative as part of a sequential design process.
An internal-use software also has to pass a three step High Threshold of Innovation test. The three-part test includes:
- The software must be innovative. The software must be unique or novel and results in a reduction in cost or an improvement in speed that is substantial and economically significant.
- The software development bears significant economic risk. The taxpayer commits substantial resources to software development and, due to technical risk, there is substantial uncertainty it will recover the resources in a reasonable time period.
- The software isn’t commercially available. A third party can’t buy, lease or license the software.
The Indago team has been working with a transportation company that specializes in providing solutions for last-minute volume and shipment changes. The company offers multiple shipping solutions, which increases savings and on-time delivery. The taxpayer created an innovative logistic software that tracks pick-up, drop-off and delivery trucks. Given the ground-breaking platform created by the client, the accumulated federal and state R&D obtained by Indago is in the hundreds of thousands range for only a few years accumulation period.
The IRS regulations also define the term “non-internal use software”. The regulations delineate this type of software as:
- Software created by the taxpayer for commercial sale, licensing or leasing.
- Software created by the taxpayer to communicate with third parties or have third parties revise their files or documents on the taxpayer’s platform system.