Facts
Wahoo Software, Inc. is a software company, which has different products to serve for a variety of industries. The company has been experiencinged net operating losses (NOL) between 2008 throughand 2011. However, after 2011, sales and revenues increased with creating net operating income. The company had acquisitions and mergers that concluded having research and development projects to update its products, such as Wahoo healthcare console, web-based directory, web-based on calls scheduling, and speech.
Issues
Wahoo Software Inc., the taxpayer, has conducted research and development projects, and all those R&D projects might be eligible for R&D credit. However, the corporate controller has several questions related to research and development tax credit. The questions include qualification requirements, treatment options, possible tax advantages of research and development credit, and documentation requirements to be eligible for the R&D tax credit.
Relevant Authorities
In generally, research and development credit creates benefit that is “ 20 percent of the exceeds any of the qualified research expenditures for a taxable year over the base amount.” However, there are certain requirements for expenditures, to be qualified as R&D expense to use related tax credit. The list of qualified R&D expenses includes in-house research and contract research expenditures amount incurred or paid by the taxpayer during the taxable year. In-house R&D expenditures includes: the sum of all wages and labor expenses that are conducted to research and development activities, sum of all supplies that are directly related to the research and experiment, and total amounts to operate and maintain facilities that are conduct to research. Contract research expenditures are expense amounts paid or incurred to a third party to conduct a research, and maximum 65% of contract research expenses are considered qualified research expenses. If an expense is not set forth in Section 41(b), a taxpayer may not claim the expense as a qualified research expenditure.
IRC §41(d)(1) states that research activities must meet four requirements to be qualified research and development expense. First, the research must relate to improved or new business components in specific areas such as quality, performance, function, and reliability. Second, the purpose of research must relate to discovering information that is technological in nature. Third, Section 174 requirements that are research expenditures must qualify as expenses under Section 174. Fourth, all research activities must be elements of processing experimentation such as confirmation of hypotheses, refining of hypotheses, or evaluating of alternatives. The key point in R&D credit is internal use software expenditures are excluded from the definition of qualified research, and if the company wants to take advantage of R&D credit, then R&D should not conduct any internal use software.