Unlocking Software Development Tax Incentives

Software development companies must continually innovate to remain competitive in the ever-evolving technology landscape. The Research and Development (R&D) Tax Credit, along with recent legislative changes, offers avenues for substantial savings and reinvestment into innovation.

For technology leaders looking to get and stay ahead in a competitive market, leveraging R&D tax incentives is not just advantageous — it's essential.

Navigating the R&D Tax Credit Landscape

Eligible technology-related activities include:

• Enhancing Software Functionality: Improvements in performance, security, and scalability.
• Developing New Software Applications: Creating applications compatible with platforms like iOS and Android.
• Automating Internal Processes: Streamlining operations through technological advancements.
• Conducting Software Testing: Engaging in activities such as regression and unit testing.
• Evaluating Alternative Solutions: Addressing technical uncertainties through experimentation.

To qualify, these activities must meet the IRS's four-part test:

• Aim to improve a product or business component.
• Involve technical uncertainty.
• Require a process of experimentation.
• Be technological in nature.

Understanding Software Categories and Eligibility

Eligibility for the R&D Tax Credit varies based on the intended use of the software:

• External-Use Software (EUS): Developed for sale, lease, or license to third parties. Think SaaS products or mobile apps.
• Internal-Use Software (IUS): Used strictly for your own business operations.
• Dual-Use Software: Serves both internal and external purposes.

Note: Internal-use software must meet a higher bar (the “High Threshold of Innovation” test) to qualify for the credit.

R&D Tax Incentives for Startups and Emerging Tech Companies

Startups and emerging tech companies often overlook the R&D tax credit, especially in the early stages of growth.

If you're a startup with under $5 million in revenue and fewer than five years of gross receipts, you may be able to apply the R&D credit against your payroll tax liability — even if you're not yet profitable.

Startups that qualify can apply up to $500,000 per year in R&D tax credits against their payroll tax obligations — a significant source of non-dilutive funding.

Recent Legislative Changes Impacting R&D Incentives

The enactment of new tax legislation has introduced significant changes to R&D expensing, including:

• Immediate Expensing of R&D Costs: Companies can now immediately deduct eligible R&D expenses or elect to amortize them for tax years beginning after December 31, 2024. However, foreign R&D expenses are not eligible for immediate expensing.
• Recapture of Previously Capitalized R&D Costs: Companies will have the ability to recapture previously capitalized domestic R&D costs by amending its tax return(s) (available to certain small businesses) or accelerating the deductibility of unamortized R&D expenses in its first taxable year beginning after December 31, 2024.
• Restoration of 100% Bonus Depreciation: Qualified assets are eligible for 100% bonus depreciation.

These changes may impact your current and prior-year tax strategy. Now’s the time to review.

Strategic Considerations Going Forward

To make the most of the available incentives:

• Document everything. Keep detailed records of qualifying R&D activities, expenses, and personnel.
• Evaluate prior tax years. You may be able to amend returns to claim immediate deductions under new rules.
• Work with a qualified tax advisor. Software-related R&D incentives can be complex. Guidance from specialists helps ensure compliance and maximize savings.
• Not sure if you qualify? Take our R&D Tax Credit Assessment to see if your software development efforts qualify for incentives.

Whether you're building new applications, streamlining operations, or investing in AI, your development work may qualify for significant tax savings. The key is knowing where to look — and how to claim them.

Let’s talk about how you can perform better, protect what you’ve built, and prosper through innovation.