It’s natural for manufacturers to think of “investing capital” as purchasing new machinery and equipment. But, there’s another investment, often overlooked, that can return tens of thousands to millions of dollars back into the business.
It all revolves around the R&D Tax Credit. Some manufacturers are in a position to invest capital into software that makes claiming the R&D Tax Credit easier, which can lead to reinvesting back in the business, often in the form of new or upgraded equipment, investing in employee retention and development, hiring critical new employees, etc.
This isn’t about being a commercial software vendor or marketing software to third parties. Manufacturers can take advantage because time spent developing or improving Internal Use Software (IUS) may count as qualified activities for the R&D Tax Credit. The most exciting part? An investment in software likely means helping your business grow faster, be more competitive, and increase profitability.
When does it make sense to invest in software? Few people in this industry can answer that better than Black Line Group’s VP and Manufacturing Practice Leader, John Madsen. In this blog, he covers:
• How software helps with efficiency, making processes smoother and training easier
• How to pay for it; upfront capital that the R&D Tax Credit helps pay for
• How to maintain the software and improve it (and claim that, too)
Want to know what types of software qualify as IUS as far as the R&D Tax Credit is concerned? Read this article!
Evaluating Your Current Software
Claiming the R&D Tax Credit begins not by looking for software that improves your processes, but by looking at how your current software meets (or doesn’t meet) your business needs. If you have security concerns, your system is no longer supported by the vendor, or the system often crashes, you should be raising a red flag.
Take note of what your employees are doing to solve the inefficiencies in your current software platform. Signs it may be time to consider a software upgrade:
• Your team may be innovative in solving problems, but what is the cost?
• Are they making excel spreadsheets to track data outside of the system?
• Are they handwriting notes from several screens to collect data?
• Are your customer service people walking the shop floor gathering data to answer customer questions?
Considering Investment Costs
When upgrading software, the cost to your company is more than simply the purchase of the system. Training and implementation are soft costs that can overwhelm and delay original predictions for improvements.
The R&D Tax Credit can offset some of this expense when qualified research and development activities are conducted. In fact, there are generally numerous activities within a software project that contain Qualified Research Expenses (QREs).
The R&D Tax Credit was designed to encourage companies to not only develop new products and processes, but also to improve existing products and processes to give you an edge in a competitive market. Take a close look at your new software project to understand the ways in which it can be innovative and improve your existing processes.
Scrutinizing System Integration
When implementing new software, consider how the new system will talk to your existing systems. It’s also important to have a defined objective for the new system, such as planning resources, determining job flow, identifying labor cost, and/or monitoring equipment output.
It comes down to clearly defining the problem you’re trying to solve today. Then also looking ahead. What data do you need from your software systems to support artificial intelligence?
Identifying Qualifying Activities
Let’s explore the Internal Use Software activities that qualify for the R&D Tax Credit. It comes down to time spent either creating IUS or improving IUS.
Creating IUS — Building proprietary software for internal use has numerous qualifying activities, such as gathering requirements and translating them into code (within the required technical environment), testing for quality assurance, plus core technical, development, and coding related activities, and more.
Improving Purchased IUS — If your company has spent time and other resources making modifications or improvements to purchased software to suit your organization’s needs, they likely qualify for the R&D Tax Credit. If it was bought and used as is, it does not. Other than that distinction, the same activities that qualify for creating IUS also qualify here, too.
Testing Qualifying Activities
Two tests help confirm if your IUS qualifies for the R&D Tax Credit.
- The software results in cost reduction, improved speed, or other measurable improvement that is substantial and economically significant.
- The software development process involves significant economic risk. This means that the taxpayer commits substantial resources to the development, and there is uncertainty due to technical risk that the resources would not be recovered within a reasonable period of time.
- The software is not available to be purchased, leased, or licensed in the commercial market and is used for the intended purpose without modifications required to satisfy the innovation and significant economic risk requirements above.
- Permitted Purpose — This is the activity intended to make or improve either a product or process that results in improved function, performance, reliability, quality or cost efficiency.
- Technical Uncertainty — This is the activity intended to eliminate technical uncertainty when developing or improving a product or process related to methodology, design, techniques, formulas or inventions.
- Process of Experimentation —This is the activity that includes a process of experimentation to eliminate or resolve technical uncertainty. During the process, various alternatives and approaches are evaluated by modeling, simulation, trial and error, prototyping and other methods.
- Technological in Nature —The process of experimentation must rely on the hard sciences (engineering, physics, biology, chemistry, computer science).
As manufacturers know, purchasing new equipment is an easy and comfortable ROI. Yet, at some point, investing in your software systems and overall platform is necessary. Understanding how software impacts how you claim the R&D Tax Credit results in identifying opportunities to reduce your tax burden, meaning more money for your business.
Software has a direct impact on the growth of your manufacturing business. Talk with a specialist about how the R&D Tax Credit can help your business remain profitable. Here’s one more bit of advice if you want to protect your business, increase profitability, and keep growing in 2021. Read our 9-point checklist! Click the link below to get it.