What software development activities and expenditures can be included in an R&D Tax Credit claim for software projects?

Companies performing qualified research in creating or improving their software may qualify for federal and state R&D tax credits for the software development activities they are already conducting. These credits are a dollar-for-dollar reduction in federal and state tax liability and could range from 6.5 percent to 15 percent of total research expenses. For example, a company employing 10 software engineers with qualified wages of $1 million could see federal and state R&D credits exceeding $100,000 for a single tax year. Below is a short list of qualified activities and the expenses eligible for the credits.

In terms of qualifying tasks, the following activities would be considered eligible for the R&D tax credit:

  • Develop new, improved or specialized technologies
  • Software developed as part of a hardware product
  • Design and develop software architecture
  • Develop new algorithms
  • Design new database management techniques
  • Develop system software, operating systems and compilers
  • Establish functional relationships between software modules
  • Program and test software source code
  • Conduct unit, integration, functional, performance, and regression testing
  • Develop feature enhancements
  • Conduct analysis for new functional software end requirements, domain, software elements, or scope analysis for a new functional software enhancement
  • Evaluate and establish functional specifications
  • Improving internal processes
  • Attending technical meetings

What R&D expenditures can be claimed for software projects?

For qualified research conducted in the United States, the main costs that can be claimed towards the R&D credit1 are:

  • Wages paid to software engineers, programmers, developers as well as those supporting or supervising the development
  • Agency workers
  • Subcontractors/freelancers
  • Cloud license for use in developing software and conducting experiments to validate its design
  • Right to use (time-sharing) computers

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Author: Tetyana Guguchkina

Download Article: R&D Tax Credit – Qualified Research Expenses for Software Development Activities

1Treas. Reg. § 1.41-2 Qualified Research Expenses.