R&D Tax Credit for Software Development Firms

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This article details the benefits of the R&D tax credit for software development firms. Software development companies and companies in related fields often do work that qualifies for the R&D tax credit. Among the types of software development that most often qualifies for the tax credit are proprietary software product development, mobile app development, website development, custom software development, and to a lesser extent, internal use software development. Some examples of the general software development and design activities that might qualify for the tax credit are alpha and beta prototype development and testing, database design, regression and unit testing, concept development and ideation, and design of software architecture. There are four main requirements that must be met by any software development project to qualify for the R&D tax credit for software development firms.

  • Permitted Purpose: To qualify a project must be intended to develop or improve a product, process, technique, invention, software, or formula.
  • Technological in Nature: The project must be undertaken for the purpose of discovering information that is related to one on of the sciences of engineering, biology, physical science, or computer science.
  • Elimination of Uncertainty: The project in question must strive to eliminate uncertainty in some form related to the optimal design, development method, or components capability.
  • Process of Experimentation: The project must utilize experimentation to evaluate one or more alternative solutions and options. This is often done through simulation modeling or the more traditional trial and error method.

Proprietary software development can qualify under many forms. Companies like Apple, Intuit, and Adobe often have the easiest time qualifying much of their research because they develop consumer products. Much of the video game development process is also likely to qualify, especially activities like creating a proprietary game engine. Companies that develop software products intended for sale or lease are among those that qualify most easily for the R&D tax credit.

Web developers often overlook the R&D tax credit and for good reason. Little of what web developers do qualifies for the tax credit. This is because aesthetic design is specifically excluded from qualified activities. HTML is too straightforward and its applications too well understood to meet the uncertainty requirement. Web developers that do extensive back end development, however, may have some activities that qualify. If your company works on back end development of web apps, CRM apps, e-commerce apps, or other projects that use traditional programming languages like C++, Java, or Python, that tie into web-based front ends, then you might qualify for the R&D tax credit.

Custom software development can also qualify for the R&D tax credit but there are two additional eligibility requirements to consider. First, the contract must pay out only if the development is a success. Otherwise there is no financial risk to your company from the research. Second, your company must keep the intellectual property rights to the software. If these two requirements are met in addition to the four basic requirements, then software developed for a third party under contract may qualify for the R&D tax credit. The process for qualifying this sort of software development can be more complex than others. Thus it is essential to consult a professional who specializes in the R&D tax credit, and particularly third party custom software development in the early stages so your company knows how to plan.

Mobile app developers these days are often startup companies. Mobile app development is still a relatively young industry, and with mobile technology changing rapidly, new opportunities are are always presenting themselves. Many startup companies don’t believe they can benefit from the R&D tax credit for software development firms because they don’t show enough profitability to benefit from the credit. However, companies may choose to wait until future profitable years to use their credit. So even if your company can’t benefit from the credit now, it might in the future, which can provide your company with the sort of extra funds it needs to pursue further development faster than it would otherwise. It’s always a good idea to talk to an R&D tax credit expert about how your company can benefit from the credit even if you aren’t immediately profitable.

Internal use software development might be done by a software development company, or by any company that needs a unique software solution for their business. Either way, it’s the most difficult type of software development to qualify for the R&D tax credit. This is because it must meet three additional requirements to the four main ones listed above. It must be innovative, differentiating itself from prior software in a unique or novel way. There must be substantial economic risk should the project fail. Third, no commercially available software is available that could accomplish the intended purpose without modifications that hit the first two requirements. The issue of qualifying internal use software development is very tricky and complex. While it can be done, circumstances under which it qualifies are rare, but it does happen. So if you have a software project at your company that is being developed for internal use, it is worth checking with an R&D tax credit expert to determine the project’s eligibility.

Overall software developers are often among the strongest candidates to benefit from the R&D tax credit. Even this being the case, many companies don’t go for it because of misconceptions about qualification. Startups often don’t understand that they don’t need to be profitable immediately to benefit from the credit. Many niche developers may not believe they qualify for the credit when in fact they do. Your company stands to lose very little by consulting an R&D tax credit expert to determine eligibility and may stand to gain hundreds of thousands of dollars or more. That’s not the kind of money any company should be leaving on the table. Contacting a company that specializes in the R&D tax credit for software development firms is the best way to begin assessing your eligibility.

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Journal of Accountancy


Washington Technology

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