Qualifying AI for the R&D Tax Credit | KBKG
Artificial intelligence (AI) has recently been a mainstay of news headlines worldwide, and for good reason. Publicly released AI tools now allow individuals and companies to generate images and text nearly indistinguishable from those created by humans.
If you are a company or have a department that develops or researches AI technology to improve industry procedures, you may be eligible for R&D tax credits. These tax credits can help reduce your overall tax burden and save money. Whether your company is a large, established organization or a recently launched startup, R&D software tax credits may interest you.
What Are R&D Tax Credits?
The R&D Tax Credit, also known as the Research and Development or the Research and Experimentation tax credit, is a federal tax credit that offers companies and organizations dollar-for-dollar tax savings for conducting activities related to designing, developing, or improving products, processes, software, formulas, and more. The point of R&D tax credits for software development, enacted in the early 1980s, is to encourage investment, innovation, and development nationwide.
Most R&D tax credit claims come from salaries paid to employees. In the case of AI, businesses that employ software engineers, machine learning engineers, business analysts, data scientists or other professionals involved in the development and testing of AI technology may qualify for the R&D tax credit.
Benefits of the R&D Tax Credit
The government incentivizes research and development through the following benefits:
- Receive up to 12 to 16 cents of state and federal tax credits for every qualified dollar in spend
- Credits can be carried forward for up to 20 years
- A dollar-for-dollar reduction in your state and federal income tax liability and lower your effective tax rate
- Improved cash flow and boosted earnings per share
- Look-back studies that discover unclaimed credits for previous tax years (usually up to three years)
- The option to utilize the startup R&D tax credit against payroll tax
Qualifying AI Activities
Many AI activities can potentially qualify for R&D software development tax credits, including:
- Creating software that recognizes and generates suggestions based on behavior
- Updating robots or AI that help employees on an assembly line
- Developing imaging processing and speech recognition software
- Creating and testing AI tax software
- Developing algorithms or architectures for the release of application software
- Educating robots to provide basic comfort and instructions to patients (see below for more on AI for the Health Care industry)
Qualifying Research Expenses
Section 41 of the Internal Revenue Code (or IRC) allows companies that develop AI software to resolve method, design, and capability uncertainties to claim specific R&D credit software development tax incentives. These incentives can help companies offset their qualified research expenses (or QREs). QREs that could qualify for the tax credit include:
- Salaries
- Supplies
- Cloud computing costs
- Contract research
Any salaries distributed to employees performing certain research activities are usually one of the largest components of a software research and development tax credit claim. Employees who utilize simulations, tests, or models to resolve technical uncertainties, as well as employees who evaluate technological alternatives for these simulations and models, can be included when calculating R&D tax credits for software development.
Other individuals, such as contractors based in the United States, who engage in similar activities or who support and supervise staff who conduct research and development activities, may also have expenses that can be included. Companies experimenting with and testing AI cloud computing services may also qualify for R&D tax credit software development.
Section 174 Changes
There have been recent changes to Section 174, pertaining to the treatment of research and experimentation expenses. These changes affect software development and may have an adverse effect on companies performing development in the AI industry just to mitigate development expenses.
New acts now require software development expenses to be amortized and capitalized over a multi-year period, beginning in 2022. Due to this, only a portion of development expenses can be deducted in the year they are incurred. At the federal level, the software development tax credit can be carried forward up to 20 years, so companies not immediately using it may still benefit from carrying it forward for future use.
Is Your Company Eligible for a Tax Credit?
Nowadays, a variety of industries are developing AI applications, many of which may be eligible for the research and development tax credit for software companies.
Health Care
The AI-associated healthcare market is growing at a rapid rate. Many software companies have developed machine learning models that can scour medical data, uncover insights, and improve the patient experience and outcome. Research on precision, clinical decision and imaging support has resulted in advancements in the healthcare AI sector.
Pharmaceutical
Research and development is essential in the pharmaceutical industry, including the research and development of AI tools. AI has revolutionized drug research with AI systems that can analyze genetic, proteomic, and clinical data to design medications. Pharmaceutical companies continue to progress AI development to ultimately benefit public health.
Aerospace
The aerospace industry has been developing AI since the invention of autopilot over a century ago. It has rapidly advanced AI technology from simple tools that maintain altitude to control systems that perform gate-to-gate operations autonomously.
Game Development
The gaming industry is worth more than $300 billion and serves as one of the largest markets directing the development of AI technology. Developers in the gaming industry create innovative technologies that improve mechanics and create a more adaptive and immersive gaming experience. Additionally, game developers who research and develop their AI-powered applications have breached other industries, selling their technology to Google Translate and Google Photos.
Accounting and Finance
The development of AI software that can identify patterns within data to predict outcomes and identify risks allows financial institutions to detect fraud quickly and efficiently. Eligible companies include those that develop generative AI for businesses or have a department dedicated to creating innovative AI for improving the finance industry.
R&D tax credit software development can help you determine your company’s eligibility.
Contact Us To Learn More About R&D Tax Credits
Artificial intelligence is a broad yet distinct category of research and development. If your company develops AI products and you want to know if you are eligible for R&D tax credits, KBKG is here to help. Our tax professionals can help you understand more about the research and development tax credit software and how it can help reduce your tax burden and improve cash flow. AI is a cutting-edge development that can be financially beneficial to your company. Contact us today to learn more about our services.