Businesses routinely develop new or improved proprietary internal use investment or valuation models, proprietary financial software, improved software algorithms for security, and new coding to improve speed and functionality.

Internal use computer software (IUS) that is developed by (or for the benefit of) the taxpayer primarily for back-office functions is eligible for the research credit if it satisfies a three-part high-threshold-of-innovation test in addition to the four-part test. The final regulations clarify that this test applies only to the software developed for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business and to dual function software.

Internal Use Software general and administrative functions are limited to:

  1. Financial management functions that involve the financial management of the taxpayer and the supporting recordkeeping;
  2. Human resource management functions that manage the taxpayer’s workforce; and
  3. Support services functions support the day-to-day operations of the taxpayer, such as data processing or facilities services.

Note that the high threshold of innovation test does not apply to:

  1. Software developed for use in an activity that constitutes qualified research,
  2. Software developed for use in a qualifying production process,
  3. A new or improved package of software and hardware developed together by the taxpayer as a single product.

Such software is not classified as IUS, and must past only the first four requirements to qualify for the R&E tax credit.

If your organization has any questions about internal use computer software, please contact a member of the Barnes Dennig team by calling 513.241.8313 or by filling out this contact form.

The final regulations are effective 10/4/16. [1]

[1] Reg. 1.41-4.