Significant Opportunities Now Exist for Businesses Developing Customer-Facing Software

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After spending over a decade on the IRS/Treasury Department’s Priority Guidance Plan, last week final regulations relating to Internal Use Software (IUS) development were finally released.  For many businesses developing customer-facing software, the long awaited taxpayer favorable outcome stemming from the new regulations may just have been worth the wait…

FINAL IUS REGULATIONS:

Published on October 4, 2016 in the Federal Register, Treasury Decision 9786 contains final regulations concerning guidance on IUS development and its eligibility for the research and development tax credit under IRC Section 41. The regulations finalize proposed regulations issued in January of 2015 (REG-153656-03), including several significant revisions and clarifications including:

  • The definition of internal-use software
  • The definition of non-internal use software
  • Significant favorable revisions to the “High Threshold of Innovation Test”
  • Guidance as well as examples related to the “Process of Experimentation Test,”  in which ALL software development projects must meet

TAXPAYER SIGNIFICANCE:

With explosive growth in the use of computer technology driving new and improved product development, operational improvements, and customer interaction, more businesses than ever are finding themselves investing in computer software development.

Despite this significance, Internal Revenue Code Section 41(d)(4)(E),  (which was written back in 1986) has provided, except as provided by regulation,  no research credit is allowed for internal use software development.  Regulations had been issued to allow research credit for internal use software development, but only when the development met three additional tests (in addition to the four standard requirements of credit eligibility), referred to as the high threshold of innovation test.   In light of this higher threshold for eligibility, the definition of “internal use” has been extremely important to taxpayers and has been an area of requested guidance for some time.

Based on the new favorable guidance outlined in the final regulations, taxpayers who were once limited by the additional scrutiny of the high threshold of innovation test will now have new opportunity to reconsider the credit.

EFFECTIVE/APPLICABILITY DATES

These final regulations are applicable to tax years beginning on or after the date of their publication in the Federal Register.  In addition, the preamble states that the IRS will not challenge return positions consistent with all of paragraph (c)(6) of the final regulations or all of the paragraph of (c)(6) of the proposed regulations for any tax year that ends on or after January 20, 2015 (the date the proposed regulations were originally effective).  This means that if your innovative software development project is eligible for tax savings through the R&D credit, you may be eligible to recoup tax savings retroactively.

If you have questions about whether or not your business may be eligible for tax savings opportunities under these new IUS regulations, please give us a call today at 440.331.0714 or contact us at http://taxcreditsgroup.com/contact-us.

Be sure to check back in on the R&D blog next week for a detailed overview on how the final regulations differ from the proposed, and what the significance of the regulations really means to taxpayers.

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