By Published On: February 14, 2023

Major Tax Savings could be underway through the R&D Tax Credit

It’s Valentine’s Day – a day of love and romance celebrated by many happy couples, and an unfortunate day of trepidation for the lonely singles.

Luckily, in recent years, whole industries have cropped up with hope of helping those in search of love find their perfect match. Of course, one of the more modern industries is that of the online dating. A recent Pew Research Center survey found that over 30% of U.S. adults have used online dating sites or mobile apps. And with the fast-past nature of today’s mobile technology, it’s likely these statistics will just continue to increase in the future, as more and more dating sites and apps continue to popup.

And while it’s undeniable that there are many users of online sites and apps, we don’t often think about the underlying technology that goes into building them out so that they are fun and simple to use. For instance, many online dating apps use modern innovations to match people with their perfect mate. From apps designed to be swiped left or right, to detailed algorithms (essentially complex mathematical equations) that match like-minded individuals through point-based systems, the modern-day digital dating industry is filled with new algorithmic technology that attempts to figure out what someone wants and doesn’t want in their ideal companion.

If your software developers are working to build out or enhance one of these innovative dating apps, it’s important to understand that at least some of their activities are likely to qualify as R&D under the IRC Sec. 41 research and development tax credit. Here are just a few examples of the types of activity that can often qualify:

  • Designing and developing new technologies, architectures, algorithms or database management techniques
  • Designing and developing new or improved features, enhancements or functionalities into the software
  • Preparing test case procedures, preparing test files, coding, compiling and refining programs
  • Prototype testing including alpha, beta, UI and UX testing
  • Revising technical specifications due to design failures or rewriting source code to resolve defects

Quite simply, if your team is performing these types of activities, there’s a good chance that your company may be eligible for the R&D Tax Credit. If so, this credit serves as a dollar-for-dollar offset to income tax liability, and for eligible startups, it can also be used to offset payroll taxes. That said, there are a few additional critical and timely items to be aware of.

First and foremost, it’s important to understand that many U.S. based software development companies are likely to believe that they are already claiming the R&D tax credit, when in fact they are only claiming the standard R&D deduction. Though easily confused as the same thing, the R&D tax credit actually serves as a credit on top of the standard R&D deduction, so claiming it, alongside of the deduction, actually creates a double benefit to the taxpayer. That said, if you believe your company is already claiming the credit, it’s a good idea to verify it with your CPA or tax preparer, just to make sure you’re not missing out on the additional savings.

Secondly, if you determine that your company is claiming the R&D deduction, but not the R&D tax credit, you’re going to want to keep on reading.

Without getting into too much complexity, a major tax code change went into effect this year that drastically impacts how U.S. based companies need to treat their R&D expenditures. [1] In the past, taxpayers have been able to deduct R&D expenses in the year they were incurred leading to an immediate tax deduction. Moving forward, taxpayers are instead required to capitalize and amortize domestic expenditures over a 5-year period, and foreign expenditures over a 15-year period. Big picture, this new law change is likely to create a substantially higher tax burden for companies this year, and over the next few years.

While this is definitely bad news for many, there is a silver lining for software companies, as the new code change also mandates that software development now be treated as R&D and it makes it subject to IRC Sec. 174 treatment. This is significant for two major reasons. First, as previously indicated, many software development firms are already expensing their R&D under IRC Sec 174, yet they have never considered claiming the R&D tax credit. Now, as they are likely to face an increase in their tax liability due to the larger amortization changes under Sec. 174, the R&D tax credit could help these same companies to offset this tax hike and soften the blow from it. Secondly, since software development has now been explicitly called out as “R&D” by Congress, one would assume that it would be more difficult for the Internal Revenue Service to challenge software-related R&D claims. Only time will tell on the latter.

Big picture, whether your business is developing the next great dating app, or improving upon the functionality of an existing retail or finance app, your efforts may well qualify for the R&D tax credit. And due to the new law change, 2023 would certainly be a good year to look into claiming it.

At Tax Credits Group, we assist software development companies with claiming the R&D tax credit. If you feel your business may qualify for this incentive, be sure to schedule a free assessment today: If you qualify, you’ll surly love the dollar-for-dollar savings to your tax liability.

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[1] This tax change came in under the Tax Cuts and Jobs Act of 2017. Within it, was a 5-year deferral of the change until tax year 2022.

About the Author: Michael Krajcer

Michael Krajcer, JD, CPA, is founder and President of TCG. He has spent his entire 35 year career working with the Research and Development Tax Credit. This includes a decade of experience auditing businesses who claimed it, and over 20 years of experience helping U.S. companies navigate through it. He has also resolved dozens of IRS and state audits of credit claims.