Qualifying For The R&D Tax Credit: Internal Use Software (IUS)

Few tax incentives are more coveted than tax credits. As dollar-for-dollar tax offsets, tax credits are almost as valuable as cash on hand. One such credit, found in § 41 of the Internal Revenue Code, allows certain business that invest in qualified research to claim a tax credit to offset some of their expenses. This is known as the Credit for Increasing Research Activities, commonly referred to as the R&D credit.

Because it is such a valuable tax incentive, businesses understandably want to do whatever they can to increase their chances of qualifying for the R&D credit. And yet, it can be extremely difficult to predict in advance whether a particular research activity will qualify. This uncertainty is even more acute in the case of internal use software (IUS). Research for the development of IUS is eligible for the tax credit only if, in addition to the standard test for qualified activities, it also passes an additional "high threshold of innovation" test.

As will be shown below, while it can be difficult to satisfy the "high threshold of innovation" test, it is not impossible. This article will outline how, despite the many hurdles imposed by the Internal Revenue Code and regulations, businesses can increase their chances of qualifying for the R&D credit.

This article includes the following sections:

Overview of the history of the R&D credit, and requirements How the R&D credit applies to Internal Use Software (IUS) Tips to increase the chance of making a successful claim This article concludes with a summary of how legal research tools can help by providing more certainty to taxpayers and tax professionals while saving time and increasing savings.

Overview of the R&D Credit

The R&D credit was originally introduced in 1981 as an incentive to businesses to spend more money on research and development. Initially a temporary measure, the credit was made permanent in 2015. This should provide some degree of comfort to businesses who may be more inclined to invest in research activities knowing that the tax credit will likely continue to be available in future tax years.

The manufacturing sector is by far the largest beneficiary of the R&D credit, accounting for 61% of the total research credits claimed, or almost $6.6 billion.[1] However, the R&D credit is not specifically targeted at any one industry sector or any one type of research.

Under § 41, in order to qualify for the R&D credit, the taxpayer must have incurred expenses which meet...