Final Regulations for Internal-Use Software Light on Changes, Remain Taxpayer-Friendly

Dean Zerbe, alliantgroup’s National Managing Director and the former Senior Counsel to the U.S. Senate Finance Committee, was quoted in Tax Notes regarding the release of internal-use software final regulations for the R&D Tax Credit on October 3. In Andrew Velarde’s article “Internal-Use Software Final Regs Light on Changes,” Zerbe offers his thoughts on the final regulations, which contain very few modifications from the taxpayer-friendly IUS proposed regs of January 2015.

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.



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