Proposed Regulations Would Expand US Research Credit for Software Development

The Tax Reform Act of 1986 enacted section 41 of the Internal Revenue Code setting forth the requirements that research projects must meet to qualify for a research tax credit. Section 41(d)(4)(E) provides that, except to the extent provided by regulations, research with respect to computer software that is developed by (or for the benefit of) the taxpayer primarily for the taxpayer's internal use is excluded from the definition of qualified research under section 41(d). The 1986 Act's legislative history indicates that the regulations were to incorporate an additional three-part high threshold of innovation test that internal use software must clear to obtain the research credit. Hence, developers of internal use software are less likely to qualify for a research credit than other software developers and developers of other types of products.