When speaking to clients about ways to manage tax credits, we often have to answer this question:
“Does the R&D Tax Credit apply to me?”
It depends. And it really depends in the area of software development or engineering improvements. Companies can overlook thousands of dollars in unrealized credits at the federal and state level if they don’t know which R&D activities to track and report.
First, understand that certain software development and engineering activities could fall within eligibility for the federal R&D Tax Credit. Since 2015, for example, the U.S. Treasury has more narrowly defined Internal Use Software (IUS), that is, software developed and used internally for general and administrative functions (including accounting). Therefore, many types of software development that were previously ineligible for the federal tax credit may now be eligible. If you develop software with the intent to sell it to outside customers, it is important to have an advisor familiar with R&D tax credits look at those activities to see if any of them qualify.
Of course, any activity considered for federal R&D Tax Credit eligibility must also meet the Four-Part Test.
Analysis of potential tax credits is unique to each business. Start by identifying your current activities and comparing them to engineering or software design and development activities that could apply. It’s worth doing this process right.
Potential R&D Engineering Activities
Does your company do any of the following? Apply the four-part test. Then set up proper time tracking and expense monitoring for these activities. That way, you’ll be more prepared and organized at tax time.
- Building information modeling or CAD modeling
- Determining alternative structural design, HVAC, lighting or water flow systems
- Designing innovative waste disposal processes integrated into a structure
- Integrating new transportation systems into structural design
- Conducting sustainable design engineering
- Unique approaches to space utilization
Potential R&D Software Design and Development Activities
Besides applying for federal credits, check into tax credits within the states that you operate because most offer tax credits to reduce income tax burdens on software development and design firms. Track your time and expenses for potential eligible activities such as these:
- Programming, compiling or testing software source code
- Designing and developing new software architecture
- Designing methods to improve the interface between various software types
- Analysis for software enhancements
- Evaluating and establishing specifications
- Various forms of new software testing