While the Research and Development Tax Credit applies to numerous industries, including manufacturing, pharmaceuticals, and engineering, it’s most frequently associated with technology companies and commercial software vendors.
The focus of this blog is on the R&D Tax Credit as it applies to commercial software vendors.
The Software Development Life Cycle (SDLC) typically consists of seven phases, and all seven phases potentially qualify for the credit. One of the areas to consider when thinking about applying for the R&D Tax Credit for your software development is the requirements and analysis phase.
Requirements and Analysis
Requirements and analysis is the second phase of the typical software development life cycle. This is the step in which, once potential solutions are identified, a company moves on to detailed information/requirements gathering and analysis. Teams consider the functional requirements of the project or solution. The solutions are scrutinized to identify the best fit for the end goal(s) of the project. This is also the time to analyze the needs of the end users to ensure the systems being considered can meet their expectations.
The end result of this step will be solidifying the business needs, determining how those needs will be met, identifying who will be responsible for which pieces of the project, and setting timeline expectations.
Here are a few specifics activities related to gathering requirements and performing systems analysis that are likely to qualify as R&D:
- Gathering Detailed Information. This includes interviewing key users and stakeholders to understand the requirements of the project to map out design.
- Defining Requirements. Documenting the requirements using the most appropriate methods so that requirements can be reviewed and confirmed with users and stakeholders to avoid misunderstandings.
- Prioritizing Requirements. Ranking requirements based on resource availability and budget, and defining the scope.
- Developing User-Interface (UI) Dialogs. Mocking up the UI using your established methodology. Then, updating, enhancing, and confirming the UI based on user input.
- Defining Functional Requirements. Defining and confirming with users the inputs, outputs, and overall processes and behavior of the system.
Four-Part Test
Potential qualifying activities then need to be put through the software industry's Four-Part Test to confirm they satisfy the criteria of each part of the test. The four parts of the test are:
- 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).
The R&D Tax Credit can help alleviate the cost of software development activities, making it easier for companies to invest in innovative ideas and solutions to meet the evolving needs of your clients. As always, consult with your R&D Tax professional for advice and information regarding the potential tax benefit of the credit.
