Four Things to Know About R&D Tax Credits for Software Companies
This article was updated August 29, 2023.
There’s no shortage of innovation in the software industry, making it a natural fit for R&D tax credits. However, improperly calculating and claiming these credits can have consequences—IRS penalties levied by federal and state tax authorities.
What Is the R&D Tax Credit?
The R&D tax credit is a dollar-for-dollar tax savings that directly reduces a company’s tax liability. There’s no limitation on the amount of expenses and credit a company can claim each year.
If the company can’t use the R&D credit immediately or completely, they can generally carry that over to prior or future years.
In addition, companies can typically amend previously filed tax to claim the R&D credit retrospectively, providing an avenue to recoup previously paid taxes.
New companies may be eligible to apply the R&D tax credit against their payroll tax during their start-up years. The R&D credit is available both at the federal and state level, with nearly 40 states offering an R&D credit to offset tax liability.
Common questions on this topic follow.
How Much Can a Company Save with R&D Tax Credits?
There’s no limit, but several factors can impact savings. Some companies save a few thousand dollars while others save millions. Generally, the more a company spends to innovate, the more they can potentially save—sometimes 10%–15% of their qualified expenses.
However, the main indicator remains the number of software engineers they employ and the engineers’ location.
Where Does the R&D Tax Credit Apply?
Because software development tends to be experimental in nature, many activities could potentially qualify for the credit. Designing new features, products, systems, and platforms, or making improvements to existing platforms could all qualify.
Even performance improvements can qualify. The development life cycle—designing a new application, writing code, testing and obtaining feedback, recoding, or redeveloping it until it actually works—lends itself well to R&D credits.