Software development is a strong candidate
for the federal research and development tax credits. Many
aspects of software development are credit eligible; these
include preliminary scoping, prototyping, core build, testing,
evolution, as well as integration with various platforms and
operating systems. In addition, many companies are adding
software-based components to their traditional product
offerings. As more companies develop such features, so too do
more companies have R&D tax credit eligibility.
Enacted in 1981, the federal Research and Development (R&D) Tax Credit allows a credit of up to 13 percent of eligible spending for new and improved products and processes. Qualified research must meet the following four criteria:
Eligible costs include employee wages, cost
of supplies, cost of testing, contract research expenses, and
costs associated with developing a patent. On January 2, 2013, President Obama signed
the bill extending the R&D Tax Credit for 2012 and 2013
tax years.
To meet fast-paced needs, software development is increasingly headed toward an "agile" model in which software quickly comes to market and is then subject to continuous maintenance and improvement. The agile model blurs the boundaries of traditional software development stages and makes every stage a potential source of R&D expense. Below are common development stages and their R&D tax credit relevancy:
The cloud is another way by which programming is becoming more agile; development stages occur in parallel with one another rather than serially. The cloud facilitates this by providing excess server capacity and a universe of development tools, many of them open source, which the developer can access at will .
In essence, the cloud is a virtual R&D playground, supplying the developer with a larger set of tools and capabilities than he would otherwise have access too. This universe of possibility allows developers to focus on making the core product offering as agile, robust, and innovative as possible.
The cloud is one of many ways in which the "connected world" has resulted in a change in paradigm. Rather than occur in silos, R&D is now a collaborative effort, supported by a wide array of coalitions, start-ups, private/academic partnerships, open-source development and even competitions where winning codes, algorithms and designs receive recognition and funding.
Consumers make up part of the connected
world, too. Data from web and Smartphone usage and from
sensors, for example, provides an ever-expanding universe of
digital information. Many firms now employ directors of
analytics to make sophisticated use of Big Data to better
define corporate strategies and understand consumer
preferences. The big data-driven insights from these analytics
often result in product offerings, algorithms, apps, and other
deliverables that are credit eligible.
More and more, companies outside the traditional high-tech industry are involved in software development. A recent Forbes article "Now Every Company is a Software Company" shows how even some of America's most venerable companies are turning to software to enhance their product lines and find new growth.
Ford Motor Company, for example, is equipping its latest vehicles with features like wifi receivers which turn its cars into mobile hotspots, software to help its vehicles maximize energy efficiency, and sensors to assist with parallel parking. The old-fashioned, utilitarian concept of the car as way of getting from point A to point B no longer captures the way Ford views cars or the needs of the people who drive them.
Some companies now engaged in major
software initiatives have no historic foundation in technology
whatsoever. McKinsey, the consulting firm, began developing
software applications to enhance their consulting and report
capabilities. Eventually, McKinsey realized these applications
held value to outside firms and began selling their software
programs, which now total twenty-one in number. This division
within McKinsey has become large enough to constitute a
sizable tech start-up by Silicon Valley standards. As a result
of software, even an industry like consulting which
historically had little R&D credit eligibility is now
generating appropriate expenses for the credit.
Early stage start-ups are often highly R&D-intensive. Moreover, the credit is in fact a credit for increasing research activities; at no time in a company's history are its R&D expenses increasing at a faster rate than as a start-up.
Lack of immediate tax capacity is not a
reason for a start up to ignore the credit: R&D tax
credits can be carried forward as many as twenty years.
Establishing R&D accounting practices early pays large
dividends down the road. Many start-ups see acquisition as
their end-game, wherein sound accounting, including R&D
credit readiness, can be a meaningful part of asset valuation.
More companies are following the successful IBM model of using data to provide solutions to a wide array of problems. Even IBM has indicated that their goal is to develop more software related to social media, cloud computing and mobile phones . Both software companies and companies now delving into software-based features and solutions should examine their R&D tax credit eligibility.
Charles R Goulding Attorney/CPA, is the President of R&D Tax Savers.
Charles G Goulding is a practicing attorney with experience in R&D tax credit projects for a host of industries.
Rachelle Arum is a Tax Analyst with R&D Tax Savers.