R&D Tax Credits for Computer Science Companies

Computer science companies are in the business of innovation. As such, they are ideal candidates for the research and development tax credit. The federal R&D tax credit was essentially authorized for the specific purpose of encouraging the research and development of new products and processes. That said, a majority of computer science companies fail to take advantage of America's largest tax incentive. In 2016 alone, nearly $16 billion in R&D tax credits were claimed, yet computer science companies continue to leave money on the table by not claiming the research and development tax credits made available to them. The primary reasons computers science companies aren't claiming R&D tax credits are they either don't know the credits exist or don't believe they qualify to claim the R&D tax credits. Computer science companies may also be unaware of some recent changes in the R&D tax credit laws that have expanded the scope of the program so that more taxpayers are able to claim R&D tax credits than ever before. The best way to learn whether your computer science activities are R&D tax credit eligible is to work with an experienced and well-qualified R&D tax credit consultant. 

Computer science companies can claim R&D tax credits

Computer science embodies innovation. Computer science is a remarkably young field, yet a revolutionary one. For a substantial period of time, computer science wasn't event recognized as a field separate from engineering and mathematics. As computers gained popularity, their functionality expanded and a new field was born. Computer science is essentially the science of solving problems with the aid of a computer. It is the the study of computers, algorithmic processes, computation, and all the associated applications and impact of the same. Computer scientists seek innovation and their research activities are perfectly well-suited to take advantage of the R&D tax credit. It is the single largest tax credit available to computer science companies. In order for your computer science company to be eligible to qualify for the R&D tax credit, it must engage in certain qualified research activities.

Arvo has worked with computer science companies across the country to help them claim the R&D tax credit. Examples of industries that employ computer scientists or engage in computer science activities include:

• Research companies
• Large computer and software companies
• Social media companies
• The government
• Large manufacturers
• Financial service providers

You don't have to be among the largest computer science companies to take advantage of the research and development tax credit. Small computer science companies and startups are even eligible to claim the R&D tax credit. In fact, recent changes to the applicable laws have made it easier than ever for more CS companies to take advantage of the R&D tax credit.

Benefits of R&D tax credits for computer science companies

The research and development tax credit is a government-sponsored tax incentive available to companies who conduct research and development within the United States. The credit was implemented as a Congressional response to the decline in research spending which negatively impacted the Country’s economic growth, productivity gains, and overall global competitiveness. The R&D tax credit was initially implemented in 1981 and has since been reauthorized several times. In 2015, when the Protecting Americans from Tax Hikes (PATH) Act was adopted, the Research and Development (R&D) credit became a permanent part of the tax code

Many computer science companies assume the R&D tax credit is available only to the big software development companies. This, of course, is not the case. You don't have to be as large as Amazon, CSC or Microsoft to be eligible for the credit. A computer science company is eligible for the incentive as long as they are engaged in qualified research activities, regardless of the size of their company. Under the current tax code, any company that develops or improves products or processes may be eligible for the credit. The number of computer science companies who engage in eligible activities is ever-increasing; computer science is, by its very nature, innovative.

Many computer science companies are unaware of the tremendous benefits of R&D tax credits. The credit is worth 7-10% of qualified research expenses. This is a dollar-for-dollar credit against taxes owed. Plus, it carries forward 20 years. For startups, applying the credit against payroll taxes is a valuable, non-dilutive funding opportunity. Eligible expenses for the R&D tax credit include U.S.-based wages, contracting, and supply costs. Most typically, wages are the largest qualified expense, but there must be nexus between the expense and qualified project. Additionally, most states offer an R&D tax credit that can supplement the federal R&D tax credit.

Computer science and R&D tax credit eligibility

Working with a professional R&D tax credit consultant is the best way for you to determine your tax credit eligibility. In order to be eligible for the research and development tax credit, your software development company must engage in qualified research. Qualified research generally is private sector or commercially driven development intended to yield innovation within a scientific or technological field. The following four-part test determines whether an activity is considered qualified research and, thus, eligible for the R&D tax credit.

Permitted Purpose

The purpose of the activity or project must be to create new (or improve existing) functionality, performance, reliability, or quality of a business component. A business component is defined as any product, process, technique, invention, formula, or computer software that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer's trade or business.

Elimination of Uncertainty

The taxpayer must intend to discover information that would eliminate uncertainty concerning the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability of development or improvement, method of development or improvement, or the appropriateness of the business component's design.

Process of Experimentation

The taxpayer must undergo a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or the method of achieving that result, or the appropriate design of that result, is uncertain as of the beginning of the taxpayer's research activities. Treasury Regulations define this as broadly as conventional implementation of the scientific method to something as informal as systematic trial and error process.

Technological in Nature

The process of experimentation used to discover information must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and may rely on existing principles of the physical or biological sciences, engineering, or computer science to satisfy this requirement. Research activities that qualify for R&D tax credits must be conducted in the U.S. If your business does any of the following, it likely qualifies for the R&D tax credit:

• • • Develops or designs new products or processes
    • Enhances existing products or processes
    • Develops or improves upon existing prototypes and software

Exclusions

Even if your work passes the four-part test, there are a few exclusions to the R&D tax credit. Expenses incurred under the exclusions will not qualify for the incentive. Some of these already appear in the four-part test, including the need to rely on hard sciences. The activity must take place in the U.S. and cannot include routine data collection or market research. Also, activities cannot receive funding from an unrelated third party because your company might not retain ownership of the resulting intellectual property. 

Arvo will work with you to help you understand what is considered qualified research for purposes of determining R&D tax credit eligibility for your computer science company.

R&D tax credits: Computer science and innovation

The field of computer science explores the practical and theoretical aspects of computational processes. Areas of research within the field include algorithms, architecture, artificial intelligence, computer vision, computational biology, concurrency and distributed computing, database systems, machine learning, machine vision, natural language processing, networks, numerical analysis, programming environments, programming languages and methodology, robotics, and theory of computation. Those who know how to create and improve software are highly marketable and are in demand. Here is just a brief list of careers that likely engage in qualified research within the computer science industry.  

• Data scientist
• Software tester
• Web developer
• Systems analyst
• Business analyst
• Product manager
• Network architect
• Software engineer
• Software developer
• Full-stack developer
• Engineering manager
• User interface designer
• Database administrator
• Cloud computing engineer
• Information security analyst
• Computer science professor
• Chief information security officer
• Information technology specialist
• Software quality assurance manager
• Mobile application designer or developer
• Research and development (R&D) scientist
• Computer scientist or computer science researcher
• Artificial intelligence and machine learning engineer

In order to be eligible to claim the R&D tax credit, computer science activities must satisfy the four-part test described above. Arvo will work with you and your team to help determine if your computer science company is eligible to claim R&D tax credits.