The IRS released proposed regulations (REG-153656-03) addressing internal-use software (IUS) under §41 on January 16, 2015. The proposed regulations define IUS as software “…developed by the taxpayer for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business”. Expenses related to IUS are generally not eligible for the R&D Tax Credit under §41(d)(4)(E)(ii) with certain exceptions. The proposed regulations:
- Define IUS and describe software not developed primarily for internal use;
- Provide that certain IUS is eligible for the R&D Tax Credit if the software satisfies the High Threshold of Innovation (HTI) test;
- Provide rules for dual-function software;
- Include examples to illustrate application of the proposed regulations for IUS; and
- Include examples under Reg. §1.41-4 to illustrate the application of the “process of experimentation” requirement for computer software [§41(d)(1)(C)].
Software will not be considered IUS if it is developed for use:
- In a qualified research activity;
- In a production process; or
- With hardware as a single product in providing services in the taxpayer’s trade or business.
The proposed regulations are generally favorable to taxpayers and afford new opportunities to reevaluate software development expenses. The IRS has indicated that it will not challenge return positions consistent with the proposed regulations for tax years ending on or after January 20, 2015. Please contact us for a free consultation if you would like to discuss.