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Software Development Industry Qualifying Activities

Because of its technological nature, the field of software development is ideal for federal research and development (R&D) tax credits. If you’re a software developer, this tax credit can reimburse you for developing new products, processes, or inventions; the credits can return a significant percentage back to you for qualified research activities and qualified research expenses. And over 40 states in the U.S. offer a state-level tax credit as well.

To qualify for the credit, your software doesn’t have to be new to the world—only new to your company.

But the IRS places all software into one of two categories: 1) external use, or third-party, software and 2) internal use software. Each is judged according to different criteria.

External Software Criteria

External software is intended for sale, lease, or license to customers. 

Here are some examples of external-use software applications that may qualify:

  • document management systems
  • educational software
  • marketing software
  • firmware

Internal Software Criteria

Internal use software is devised to support a business internally, to be used for administrative, financial, or HR management purposes or to accomplish support services within a business. 

But internal software must meet more stringent requirements. It must be highly innovative and be unique in the marketplace. (External use software doesn’t have that requirement, because it’s based on an original platform.)

In addition to the four-part research test, internal use software must meet a heightened three-part test:

  1. The software must be highly innovative.
  2. Its development must introduce significant economic risk.
  3. A similar product must not be available commercially.

To determine the presence of significant economic risk, the internal software must pass an additional two-part test. 

  1. Your client’s company must commit significant resources. 
  2. Substantial uncertainty must be involved. Can the R&D investment be recouped within a reasonable amount of time?

Qualifying Activities

Here are some examples of Software Industry activities that the IRS deems as qualifying for the credit:

  • Alpha/beta testing
  • Application and platform design and testing
  • Coding, programming, testing (such as for functional, integration, or user interface purposes)
  • Developmental cloud computing activities
  • New architectures, new algorithms, or new database management techniques
  • Software and hardware product development to further communication and interaction
  • Specialized technology design (such as for image processing, artificial intelligence, or speech recognition)
  • System software development (for example, operating systems or compilers)

Qualified Research Expenditures

Qualified Research Expenditures (QRE) are expenses judged by the IRS as acceptable for the credit. They include: 

  • wages of the employees who carry out the R&D
  • the supplies used during the R&D process
  • a portion of what a contractor expends on R&D activity.

Expenses could include cloud computing costs and costs associated with offsite servers.

Documentation Is Key

You must have substantiation to defend the credit and support it when you go to file. 

  • Track the list of projects or revisions. Each version of the release would be a new project.
  • Keep a list of projects and what their staff is working on.
  • Have time tracking in place.
  • Include employee titles.

Case Study

Find Out If You Qualify

The R&D tax credit can provide a hidden but immediate source of cash for you from prior years, and it can significantly reduce your current and future year’s federal and state tax liabilities. You can plow your substantial tax savings back into your business, so that you can undertake even more research and qualify for additional credits! 

To get a R&D tax credit study, only rely on a specialized company with both engineering and accounting capabilities that can undertake a full-fledged technical study. 

Getting an R&D Tax Credit Analysis to see if you qualify is the first step!

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Case Studies R&D Tax Credit


R&D Tax Credit Case Study for Specialty Manufacturer in Oregon

1 Year Tax Savings: $18,078 (Federal Only) Study Highlights   Wages $525,358 Supplies $26,953 Rental or lease of computers 27.5-Year Contract Research $11,760 Total Qualified …


R&D Tax Credit Case Study For Specialty Manufacturer in New York

1 Year Tax Savings: $18,078 (Federal Only) Study Highlights Wages $358,407 Supplies $26,953 Rental or lease of computers 27.5-Year Contract Research $14,227 Total Qualified Research …

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R&D Tax Credit Case Study for Software Developer in Texas

1 Year Tax Savings: $72,430 (Federal Only) Study Highlights Wages $1,342,919 Supplies $0 Rental or lease of computers $0 Contract Research $0 Total Qualified Research …

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