Final Regulations for Internal-Use Software Light on Changes, Remain Taxpayer-Friendly
Last year’s proposed regulations were significant to taxpayers in that they both clarified and narrowed the definition of IUS, which has a higher standard to qualify for the R&D Tax Credit than does traditional software development. By narrowing the definition of IUS to software that is used for general and administrative (G&A) functions (defined as those related to financial management, human resources and support services), the IRS and Treasury effectively broadened the application of the credit to allow more businesses to claim the incentive. The final regulations are essentially a follow up to last year’s proposed regs, and according to Zerbe, will be extremely beneficial to a wide range of companies:
Dean Zerbe of alliantgroup said that the companies that benefit most from the final regs are those that are excluded from being subject to the heightened internal-use software standard.
“The final regulations make clear that companies developing software designed to interact with their clients are exempt from the high tests for internal-use software — and these companies can now potentially qualify much more easily for the R&D Tax Credit,” Zerbe said.
The standard for IUS to qualify for the R&D Tax Credit remains the high threshold of innovation test, which is a higher threshold to qualify for the credit than non-IUS development. What the final regulations have done however is clarify a key requirement within the high threshold of innovation test—the definition of uncertainty.
Last year’s proposed regs provided that substantial uncertainty “existed if information available could not establish the capability or methodology for developing or improving software.” The final regs however removed the language of “capability or methodology” to emphasize that “the focus of the economic risk test should be on the level of uncertainty that exists and not the types of uncertainty.” This change will have the impact of expanding what is defined as uncertainty, a development that according to Zerbe, will work to the benefit of taxpayers:
Zerbe said that the regs were good news for businesses and that the finalization of the taxpayer-friendly regs provided greater certainty for business planning purposes.
“The final regulations aren’t a big change from the proposed regulations, but it was useful that the Treasury and IRS took to heart the significant concerns raised by practitioners that the definition of uncertainty in the proposed regulations was too narrow,” Zerbe said. “While Treasury and IRS don’t believe the language change in the final regulations is substantial, we believe that in practice the new, broader definition of uncertainty will give comfort to taxpayers.”
Contact us today for more information on the R&D Tax Credit and what these regulations could mean for your business.
About the Author
Dean Zerbe is alliantgroup’s National Managing Director based in the firm’s Washington, D.C. office. Prior to joining alliantgroup, Zerbe was Senior Counsel and Tax Counsel to the U.S. Senate Committee on Finance. He worked closely with then-Chairman of the Finance Committee, Senator Charles Grassley, on tax legislation. During his tenure on the Finance Committee, Zerbe was intimately involved with nearly every major piece of tax legislation that was signed into law, including the 2001 and 2003 tax reconciliation bills, the JOBS bill in 2004 (corporate tax reform) and the Pension Protection Act.