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On October 4, 2016, the IRS published new regulations in the Federal Register detailing the rules for claiming software development under the Section 41 Research Credit. These rules are provided in Treasury Decision 9786 (opens PDF in new window). In a nutshell, the new rules clarify three important points:

1) Software that is developed for sale to third parties qualifies for the credit as long as the effort satisfies the key criteria. That is, the software must attempt to achieve a new or improved capability that attempts to overcome technological uncertainty.

2) Some internal-use software that is intended to provide new or improved interaction with third party customers or other external entities can also qualify, provided that a process of experimentation was required in order to achieve the new capability.

3) Software that is intended solely for internal use, such as an inventory control system or the like) is generally not eligible for tax credit support unless the software itself represents a significant gain in the field of computer science.

These basic findings are not new, but the latest update provides clarity to passages that were formerly somewhat ambiguous. Ultimately, the goal of the federal tax credit is to encourage companies to take financial risks, and to do so here in the United States. It has long been recognized that those companies engaging in serious technological development efforts are more likely to weather the storms of downturns and to prosper under favorable economic conditions.

As always, we at TCA stand ready, willing and able to help you with any questions you have about this issue or anything else related to federal or state research credits. Contact us today via email or call us at 508-842-3232 for your free consultation.

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