Most software
development companies are missing out on 5, 6 or 7 figure federal tax credits.
The existing R&D Tax Credit is overlooked because most software development
companies do not understand that their every day activities already qualify for
the credits. The IRS recently relaxed the rules as to what constitutes R&D
so many companies are unaware that they now qualify for this great tax
incentive.
And in most cases,
neither does your CPA understand because it requires very specialized knowledge
and that's why they have never approached you.
The R&D Tax credit
has been around since 1981 and its main objective is to help keep jobs in the
US. The tax credit encourages innovation and the IRS rewards those companies
who are willing to innovate here in the US by designing new software or
improving or upgrading existing software with functional features.
Since the incentive is to encourage employment for US workers, it is a
wage-based credit.
In 2001, the IRS
modified the definition of what constitutes R&D activities. The
qualified activities must involve the design and/or the development of any New
or Improved Business Component. The term business component is
pretty vague and ambiguous so they further defined business component and one
of those components was Software (Internal and External).
Let's look at External
Software first since this is the easier to understand and most relevant to
software development companies. Very simply, software to be sold, leased, or
licensed to unrelated third parties is considered External Software.
Otherwise, software is
presumed to be for internal-use. For example, computer software may serve
general and administrative functions of a company. General and administrative
functions include, but are not limited to, functions such as payroll,
bookkeeping, financial management, financial reporting, personnel management,
sales and marketing, fixed asset accounting, inventory management and cost
accounting.
So, in the eyes of the
IRS, External Software is the area where software development companies can
take advantage of this great tax incentive.
Some of the activities
that would qualify for the credit include:
·
Designing Software
·
Coding
·
Programming
·
Improving Application
Features
·
Functionality
Improvements
·
Alpha, Beta Testing
·
Improving Modules
Ironically, bug fixes do
not qualify. As usual with the IRS, the tax code is complex and you
need knowledgeable people with software engineering backgrounds and
Intellectual Property attorneys to interpret the law to make sure you are
taking the credit properly.
Another outstanding
benefit is that you can go back three open tax years and recover those missed
tax credits in the form of cash back from the IRS. Then for current
year and going forward, your company can take dollar-for-dollar reductions in
its tax liability.
Here is an example of a
software development company that sells software for the financial services and
banking industries and their Net R&D Tax Credit:
Average 4 year payroll:
$6.5 Million
Net R&D Tax Credit
Benefit for Tax Years 2004 through 2007: $500,000.
As you can see there are
substantial benefits from the R&D Tax Credit incentive. Remember, this is a
tax credit, so consider the amount of revenue that would need to be generated
to create a bottom line profit of $500,000.
In conclusion, even
though the explanation of Software External Business Component is pretty
straightforward, the activities that actually qualify are again more
complex. A simple example is that bug fixes do not qualify.
In order to properly
determine qualifying activities and create the supporting documentation to
substantiate the credits requires software engineering expertise as well as an
Intellectual Property Attorney's understanding of the relevant law. Even though
this is a complicated area of the R&D Tax Credit, you should seek a firm
that is properly staffed with software engineers and IP attorneys to perform a
study because of the high return on investment. If you do not want to lose your
credit for 2005, contact a firm soon because the last date to recover those
missed credits could be as early as March 15.
The authors are Karim
Solanji, J.D., a Director with Paradigm Partners and Mark Lauber, VP of
Marketing at Paradigm Partners. Paradigm Partners is a national tax consulting
firm specializing in the R&D Tax Credit. Mark's email is MLauber@ParadigmLP.com and
his phone number is (281) 558-7100. Our website is http://www.ParadigmLP.com
Article Source: http://EzineArticles.com/?expert=Karim_Solanji
Article Source: http://EzineArticles.com/2004702
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