The modern definition of the software industry and the R&D tax credit.

It’s no surprise that companies in the software industry are some of the largest benefactors of the R&D tax credit.

In recent years, tangible and packaged software products have largely been replaced by software-related services like the cloud-based software as a service (SaaS), cloud storage and computing, mobile app development and hosting. Software sub-industries can include Software Publishers, Computer Systems Design and Related Services, Data Processing, Hosting and Related Services, Internet Publishing and Broadcasting and Web Services.

Tri-Merit’s job is to keep up with these changes and help you identify activity that can get you the largest possible return allowed through the R&D tax credit.

Qualified Activities for Software Developers

Like all companies who wish to claim the R&D credit, software developers must meet the IRS’ four-part test. The IRS considers activities related to the software development process to determine what qualifies for the R&D tax credit. These activities begin the moment the qualifying company decides what software they want to develop and carries through to the mapping out of a plan, meeting the design requirements and releasing the software for commercial use.

Qualified activities include:

  • Concept development/brainstorming alternatives
  • Requirements/feasibility analysis
  • Alpha/beta testing
  • Architecture design
  • Proof of Concept/writing test code (prototype)
  • Programming/coding
  • Regression testing
Coding Software

R&D Credit for Internal Use Software

In an R&D tax credit analysis, the IRS makes a distinction between software that is to be sold for commercial production or intended for use by 3rd parties (such as the examples mentioned above) versus internal use software that is developed by the taxpayer for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business.

Companies in certain sectors such as banks, retailers, brokers, insurance companies, hedge funds and financial service companies often have large IT departments that develop software for their own operations. This potentially makes them eligible for the R&D credit as well.


Internal use software must pass the High Threshold of Innovation test. Examples include:

  • Payroll/Billing
  • Warehouse Management System
  • HR

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