Article

R&D credit opportunities for software and technology companies

Software development and technology companies are experiencing constant pressure to remain competitive, and surpass competitors, in a fast-evolving market of new technology trends such as internet of things (IoT), artificial intelligence (AI), blockchain, machine learning, cloud computing, data analytics, automation and cybersecurity, forcing these companies to reevaluate and change the ways they design and develop products and platforms.

Companies today are not only devoting extensive efforts, expenditures and time into developing new innovative offerings using these technologies, but also spending significant resources to reinvent the way they do business, blurring the line between technology companies and other industries. More companies are investing in the development of innovative technology offerings as well as transforming their businesses by adopting time- and money-saving technologies, such as automation, AI and machine learning.

Fortunately, federal and state governments offer R&D credits for organizations of all sizes developing or incorporating these technologies. R&D credits result in a dollar-for-dollar reduction in income taxes and, if qualified, payroll taxes, providing cash flow for future investments in technology. The activities need only be evolutionary to the organization itself, not to the industry as a whole, in order to qualify.

Projects or activities must meet four criteria in order to include the related wages, supplies, cloud service provider costs or contract research costs in the R&D calculation.

1. The activity must be technological in nature. The activity must be based on the principles of a hard science like software engineering or computer science.

2. The activity must be for a permitted purpose. The activity must involve the creation of a new or improved level of: function, performance, reliability or quality.

3. The activity must involve the elimination of uncertainty. The activity must explore what was not known at the start of the project.

  • Can we develop it?
  • How will we develop it?
  • What is the appropriate design?

4. The activity must involve a process of experimentation. Substantially all activities must include elements of experimentation such as:

  • Evaluating one or more alternatives
  • Performing testing or modeling
  • Examining and analyzing hypotheses
  • Refining or abandoning hypotheses

A wide range of technical activities related to the development of these products and platforms may qualify for the R&D credit. Consider the examples below:

  • Any software design/development activities directed at resolving software development uncertainties through an iterative process
  • Designing and developing new products and/or product enhancements
  • Developing product specifications or requirements, such as functional, design or test specifications
  • Designing and integrating applications and technologies
  • Developing new or improved technologies (e.g., new algorithms or methodologies)
  • Designing, developing and testing client-specific applications
  • Designing and developing software architecture
  • Programming software source code
  • Conducting functional and/or technical testing to validate design
  • Compiling and testing source code
  • Involvement in technical design/development meetings
  • Direct technical supervision/support of the above activities

The following demonstrates how a technology organization may take advantage of the R&D credit:

Case study

A technology company’s in-house engineering and development teams create innovative platforms that integrate their customers’ disparate payment channels into one. The development team has grown over the years in order to address technical challenges and uncertainty associated with the activities related to new integrations, new product features and higher volume, which means the R&D credit has also grown:

As the company continues to innovate, it will keep receiving benefits from the R&D credit, including:

  • Reduce its tax liability
  • Increase its cash flow
  • Increase and optimize its investment in new technology

Take advantage of R&D credit opportunities

Baker Tilly has an experienced team of R&D professionals who will work with you to develop an efficient and cost-effective approach for identifying and documenting eligible R&D activities and costs. We have assisted many clients in a variety of industries in identifying, documenting and sustaining federal and state R&D credits through a comprehensive understanding of their business operations.

Senior Consultant Logan Monson contributed to this article.

For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.

--

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

Next up

Practical GASB 89 implementation for utilities