Navigating The R&D Tax Credit: Internal Use Software

David Finley | Source Advisors

June 1, 2020. 4 min read

Internal Use Software (IUS) includes software applications, operating systems and related resources used to run a business and serve customers. Many small, midsized and even larger U.S. companies currently do not take advantage of Federal & State tax credits available for IUS research and development (R&D).

Companies often don’t seek R&D credits, because they don’t realize the credits are available to them or believe they don’t qualify. Others think it’s not worth the effort and are concerned that taking the credit increases their audit risk.

Facts:
  • Companies are successfully applying for and receiving credits that provide hundreds of thousands to millions of dollars in tax savings or refunds.
  • These savings are being realized from both a company’s current and prior year tax returns.
  • Companies can take R&D tax credit for development of both IUS and software that is sold or licensed to customers.
What industries typically qualify for IUS R&D credits?

While software-for-sale is largely the domain of IT companies, IUS is found in a variety of other industries, particularly in the services sector where technology is used to gain a competitive advantage to improve customer experience, expand product and service offerings, and streamline operations. Some industries rich in IUS R&D include:

Information Technology Financial Services Travel
Healthcare Real Estate Retail
Will my software pass the IUS 3-Part Test?

When an activity has been identified as IUS, it must meet an additional 3-Part Test as well as the standard 4-Part Test for all other R&D activities. The additional 3 tests are:

  • Innovative – The internal use software developed should have been created with the intent to provide reduction in costs, improvements in speed, or other improvements that are substantial and economically significant.
  • Significant Economic Risk – The internal use software developed should have required substantial resources in development and substantial technical uncertainty due to the technical risk that resources may or may not be recoverable within a reasonable period of time.
  • Not Commercially Available – The internal use software developed should not be available for purchase and use without modifications.
Are IUS R&D credits worth pursuing?

Simply determining whether software is for internal use or for sale can be difficult. The line between company and customer use can be blurry and the proliferation of delivery options from disks and downloads to leases, licenses, Software-as-a-Service (SaaS) and Cloud services further complicates matters.

That being said, companies are quickly expanding their use of technology, and the relentless, rapid evolution of that technology requires them to invest continually in improvements. As a result, there is a significant increase in the number of companies that are investing in IUS development.

Many firms refer their clients to specialized R&D Tax Credit firms, such as Source Advisors, that help identify qualifying R&D activities, carefully document claims, and present those claims in a coherent, understandable manner to help companies capture significant tax savings.

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