Start here to get a quick idea if you qualify for the research credit. (And remember, this web site specifically relates to software.)

Basics

Qualification for -- and the amount of -- the tax credit depends primarily on the following factors:

1. What allowable activity are you claiming (Qualified Research Activity or "QRA")?
2. What allowable expenses related to the activity can be claimed (Qualified Research Expenses or "QRE")?
3. Is the activity for commercial or internal use? (An important distinction unique to software.)

Allowable Activity (QRA)

Unfortunately, there is no simple, definitive checklist for exactly what may or may not qualify. Rather, there is a spectrum from likely to unlikely of what may qualify that can be categorized as follows:

1. LIKELY to qualify.
2. POSSIBLY will qualify.
3. UNLIKELY to qualify.

(For more information, refer to the IRS Audit Guidelines on the Application of the Process of Experimentation for all Software.)

Likely to Qualify

Activity in this category usually qualifies.

• The initial release of an application software product.
• The development of system software, such as operating systems and compilers which often includes the development of specialized technologies, such as image processing, artificial intelligence, or speech recognition.
• Software developed as part of a hardware product that itself qualifies wherein the software interacts directly with that hardware in order to make the hardware/software package function as a unit.

Possibly Will Qualify

Activity in this category is equally likely to qualify or fail to qualify.

• Functional enhancements to existing software applications/products.
• Software developed as an embedded application, such as in cell phones, automobiles, airplanes.
• The development of software utility programs, such as debuggers, backup systems, performance analyzers, data recovery, etc.
• Changing from a product based on one technology to a product based on a different or newer technology (e.g., switching from a hierarchical database technology to a relational database technology).
• The adaptation and commercialization of a technology developed by a consortium or an open software group.

Unlikely to Qualify.

Activity in this category usually fails to qualify.

• Maintenance of existing software applications/products.
• Software application configuration.
• Reverse engineering.
• Performing studies, or similar activities, to select vendor products.
• Detecting flaws and bugs in software.
• Modifying an existing software business component to make use of new or existing standards or devices, or to be compliant (i.e., certified, validated, etc.) with another vendor’s product or platform.
• Developing a business component that is substantially similar in technology, functionality and features to the capabilities already in existence at other companies.
• Upgrading to newer versions of hardware or software, or installing vendor fix releases.
• Re-hosting or porting an application to a new hardware (e.g., from mainframe to PC) or software platform (e.g., Windows to UNIX), or rewriting an existing application in a new language (e.g., rewriting a COBOL mainframe application in C++).
• Data quality, data cleansing, and data consistency activities.
• Bundling existing individual software products into product “suites” (e.g., combining existing word processor, spreadsheet, and slide presentation software applications into a single “suite”).
• Expanding product lines by purchasing other products.
• Interfaces (i.e. APIs)
• Vendor Product Extensions.
• Graphical User Interfaces (“GUI”).

Allowable Expenses (QRE)

TODO.

Commercial v. Internal-Use Software

Of the types of technologies that may be considered for the research credit, software alone differentiates between commercial and internal-use. Does it matter? Yes, quite a bit. To date, it is significantly more difficult for internal-use software ("IUS") to qualify than commercial.

What's the definition of commercial software? U.S. Treasury Department December 2001 Proposed Regulations (66 FR 66362) states that commercial software is:

software that is developed by (or for the benefit of) the taxpayer primarily to be commercially sold, leased, licensed, or otherwise marketed, for separately stated consideration to unrelated third parties

What's the definition of IUS?

Everything else.

Be very clear: In its current incarnation and as interpreted by the Tax Department, the research credit favors commercial software development over IUS. You may or may not agree that this should be the case but that's how it is. Keep it in mind.