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You’ve just finished a successful software project, and the coffee is still warm from your recent victory. But as you begin to wind down, the reality of accounting and taxes sinks in. Suddenly, you feel less like a conqueror and more like a deer caught in the headlights. You know the IRS has an R&D tax credit for software development, and you probably even qualify for a sizable refund. But as you begin to dig through the documentation, you realize it’s going to be a long and painful road. This pain is especially real for small businesses with limited resources. The good news is that there are ways to mitigate this. In this article, we’ll explain how R&D tax credit software development can ease your burden and help you get the money you deserve faster.
To help small businesses like yours with this task, Haven offers accounting services for small businesses that allow you uncover eligible R&D expenses, calculate your credit, and file your tax return with confidence.
Table of Content
Who Qualifies for the R&D Tax Credit in Software Development?
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Who Qualifies for the R&D Tax Credit in Software Development?
The R&D tax credit is a valuable incentive for software companies in the U.S. that invest time and resources into developing or improving products, processes, or technologies. Thanks to legislative updates, such as the PATH Act of 2015 and the Inflation Reduction Act of 2022, the credit is now more accessible and impactful than ever, especially for start-ups and small to mid-sized businesses.
Eligibility: Software Development Activities That Qualify
You don’t have to invent entirely new technologies to qualify. If your software development is new or improved within the scope of your business, and you encounter technical challenges in the process, you could be eligible.
To qualify, the software project must meet the four-part test:
1. Technological in Nature
The work must rely on principles from fields such as computer science or engineering, rather than marketing, social sciences, or routine data entry.
2. New or Improved Business Component
You must aim to create or enhance software functionality, performance, reliability, or quality. Cosmetic changes don’t count; functional improvement is key.
3. Process of Experimentation
You must systematically evaluate technical options. This includes prototyping, coding trials, modelling, and user testing.
4. Technical Uncertainty
There must be a genuine question about whether or how a technical goal could be achieved, and your team must attempt to resolve this.
This applies whether the software is for external use (sold or licensed to customers) or internal use (developed for internal operations). However, internal-use software must meet additional criteria to qualify.
Which Companies Qualify?
Companies across a wide range of industries may qualify, but for software developers, qualification usually hinges on whether you:
Build custom software or apps
Develop APIs, algorithms, or machine learning models
Improve software architecture or database performance
Create new platforms, integrations, or product features
Start-ups and small businesses are especially well-positioned under current law.
Two Main Categories of Qualifying Companies
Any U.S. company performing qualified research and development (R&D) can apply the credit against its federal income taxes. If unused, the credit can be carried forward for up to 20 years.
Start-Up Eligibility
(Payroll Tax Offset) A “qualified small business” can apply up to $500,000 per year of the credit against employer-paid Social Security tax (FICA). To qualify for the payroll offset, you must have less than $5 million in gross receipts in the current year.
You must have had no gross receipts for more than five consecutive years before the current year. This provision is especially valuable for pre-revenue or early-stage software companies that haven’t yet turned a profit, allowing you to benefit immediately from your R&D investments, instead of waiting for future profitability.
Who Claims the Credit?
C Corporations apply directly on their business tax return. S Corporations and partnerships pass the credit through to individual shareholders or partners, allowing them to claim it on their returns. Eligible small businesses (with average annual gross receipts of under $50M over the last three years) may now apply the credit against the Alternative Minimum Tax (AMT), making it more usable in more cases than before.
If your company is developing software and facing technical challenges, even if it’s just “new to you,” you may qualify for the R&D tax credit. Whether you’re improving functionality, building new features, or tackling back-end performance issues, it's worth evaluating your eligibility. And if you’re a start-up, the ability to offset payroll tax could provide a direct cash benefit right away.
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What Software Development Activities Qualify?
When it comes to claiming the R&D tax credit for software development, eligibility largely depends on whether the project meets specific technical and financial criteria. Both external-use and internal-use software may qualify, though internal-use software must meet a higher threshold of proof.
Qualifying External-Use Software Activities
External-use software is developed to be sold, licensed, or otherwise provided to third parties. As long as the development meets the standard four-part test, technological in nature, seeks functional improvement, involves technical uncertainty, and follows a process of experimentation, it may qualify for the R&D credit.
Examples of external-use software that may be eligible:
Document Management Systems
Educational Software Platforms
Marketing Automation Tools
Firmware Development
Cloud-Based Applications
Mobile Applications
AI and Machine Learning Models
These can include both fully custom builds and significant functional enhancements to existing platforms.
Internal-Use Software: Additional Requirements
Internal-use software (IUS) refers to software developed for use within your business rather than for sale or licensing. This may include software used for:
Financial reporting and accounting systems
HR platforms or applicant tracking
Customer support systems
Inventory or supply chain management
Internal-use software must meet both the standard four-part test and an additional three-part test to qualify:
Innovative Outcome: The software must deliver a substantial and measurable improvement to existing processes, rather than merely providing routine upgrades or maintenance.
Significant: Economic risk development requires a substantial commitment of resources and carries a real risk of failure. That means you're investing without certainty that the project will succeed or deliver a return in the short term.
Unavailability of Commercial Alternatives: The software can’t be something you could simply buy off the shelf. It must require significant modification to suit your business’s specific needs.
Assessing Economic Risk
To determine whether your project meets the significant economic risk threshold, consider: Have you invested a considerable amount of internal time, money, or both? Was there uncertainty at the outset about whether the project would meet performance goals or function as intended? If the answer is yes to both, your development is likely to qualify under this test.
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Let your business take flight while Haven manages your financial runway. Built by founders for founders, we handle everything from daily bookkeeping to complex tax filings and R&D credits that put cash back in your pocket, as well as fractional CFO services.
Join 400+ startups who've saved millions in tax credits, countless hours of administrative work, and never missed a filing deadline, all while accessing 24/7 Slack support from CPAs who understand the unique challenges of growing businesses.
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How to Document and Claim the R&D Tax Credit
Proper planning and documentation are key to claiming the R&D tax credit. Following the IRS rules and guidelines for documenting your tax credit claim will ensure that you maximize your benefit and minimize the risk of an audit.
Why Documentation Matters
The IRS requires detailed documentation of your research projects and activities to substantiate any tax credit claims. Proper documentation helps prove that your software development projects meet the IRS’s eligibility criteria and ensures that your claim is defensible in case of an audit. At a minimum, you should maintain:
Project Descriptions: Outline the purpose, objectives, and technical challenges of each project.
Time Tracking Logs: Record hours worked by employees directly involved in qualifying activities.
Technical Reports: Provide evidence of experimentation, testing, and problem-solving.
Financial Records: Include payroll details, contractor invoices, cloud service receipts, and costs of materials and supplies used in development.
This level of documentation helps clarify which activities and costs meet the IRS’s standards for Qualified Research Expenses (QREs).
Streamlining Recordkeeping
To simplify compliance, many companies use project management tools (such as Jira or Asana) or specialized R&D tax credit software. These platforms can help:
Categorise qualifying vs. non-qualifying activities
Link technical work to specific employees and cost centres
Generate reports and audit-ready summaries
Monitor progress against R&D milestones in real-time
Integrating time tracking and documentation with your day-to-day workflows reduces the risk of underreporting or misclassifying expenses.
Steps to Claim the R&D Tax Credit
Identify Qualifying Projects and Expenses. Review all development work to determine which projects meet the four-part test. Qualifying expenses typically include:
Wages for employees performing or supervising qualified research
Supplies directly used in the development process
Contract Research Costs (outsourced development)
Cloud Computing Services are used for development or testing environments
Complete IRS Form 6765
This is the official form used to calculate and claim the federal R&D credit in the United States. Your entries should reflect total QREs and any carryforward or payroll tax offset elections.
Prepare a Technical Report
While not formally submitted with your tax return, a detailed technical report is essential. It should explain:
Project goals and uncertainties
Technologies used
Stages of experimentation
Final results and technical outcomes
Consult the Right Experts
While it’s possible to navigate the credit independently, many businesses find value in working with R&D tax credit specialists or experienced tax advisors, such as Haven. Haven R&D tax credit professionals:
Help identify overlooked qualifying activities
Ensure accurate documentation and reporting
Keep you compliant with evolving regulations
Maximise the value of your claim while reducing audit risk
With proper documentation, planning, and guidance, claiming the R&D tax credit can unlock substantial value for software development companies. The key is to treat recordkeeping not as an afterthought, but as a routine part of your development workflow.
Key Changes and Considerations Going Forward
Starting in 2022, the Tax Cuts and Jobs Act made a significant change in how companies can deduct R&D expenses. Instead of fully deducting their R&D expenses in the first year they are incurred, companies must now amortize domestic R&D expenses over five years and international expenses over 15 years.
This change impacts cash flow because it reduces immediate tax relief, even though companies can still claim their R&D tax credits. As companies approach their R&D tax credit claims this year, they should keep in mind the extended recovery period for deductions and strategize on how best to manage their R&D budgets under the new rules.
Expanded Eligibility to Include Emerging Technologies
If you thought the R&D tax credit only applied to traditional technology, think again. The IRS has expanded its definition of qualifying R&D activities to include advancements in emerging technologies like:
Artificial intelligence
Machine learning
Quantum computing
Renewable energy technologies
These updates reflect the evolving nature of technology, and software companies investing in or creating platforms that utilize these advancements should be especially aware of the potential for tax credits. For instance, if your business is innovating artificial intelligence to improve scalability, efficiency, or user interaction models, you may qualify for R&D tax credits.
Greater Access for Startups
Recent legislation has made it easier for startups to access the R&D tax credit. The Inflation Reduction Act of 2022 increased the amount that qualified small businesses can use to offset payroll taxes from $250,000 to $500,000.
This change enables startups that may not yet be profitable to receive an immediate cash benefit from the R&D tax credit by applying it directly against their payroll tax liability, rather than waiting to offset income tax liability.
State-Level Credit Opportunities
Many U.S. states offer their R&D tax credits, often with separate definitions, calculation methods, and documentation standards. This includes large economies like:
California
Texas
New York
As companies approach their R&D tax credit claims this year, they should keep in mind that state-level credits can provide valuable additional savings on top of federal credits. To maximize benefits, businesses should track R&D spending at the state level for accurate apportionment and stay current with state-specific compliance requirements and deadlines.
Book a Call to Learn More About our Accounting Services (Trusted by 400+ Startups)
Haven manages your financial runway. Built by founders for founders, we handle everything from daily bookkeeping to complex tax filings and R&D credits that put cash back in your pocket, as well as fractional CFO services.
Join 400+ startups who've saved millions in tax credits, countless hours of administrative work, and never missed a filing deadline, all while accessing 24/7 Slack support from CPAs who understand the unique challenges of growing businesses.
Book a call today to learn how our dedicated team can help you focus on building rather than bookkeeping.