Software and the IRS

The IRS issued proposed regulations on Jan. 20, 2015 that would permit companies to benefit from a research and development credit for software it develops.

Even though it is used for the taxpayer’s internal operations (software developed for customer use has been eligible for the credit for many years). These rules can apply to any company, not just software companies. The regulations are proposed, the IRS stated that they would not challenge return positions for returns filed currently.

The software must meet the following criteria (in addition to others) to be eligible for the credit:

  1. The software is innovative (as were the software results in a reduction in cost, or improvement in speed, that is substantial and economically significant)
  2. The software development involves significant economic risk
  3. The software is not commercially available for use by the taxpayer

Because the regulations are still forming, I recommend speaking with a tax adviser before attempting to take the credit. As with any IRS regulations, clear, contemporaneous, and accurate documentation is necessary to sustain deductions.

IRS Repair Regulations

The IRS implemented new repair regulations from Jan. 1, 2014 that define which expenditures are repairs/maintenance (RM) and which are capital.

Businesses, or anyone with depreciate-able property (for example, someone renting a summer home) will deal with these rules for the first time this tax season. This is important to business managers and owners because RM = current year tax deduction, whereas capital expenditures = delayed deduction.

The new regulations define:

  1. What qualifies as RM and what is capital
  2. The minimum amount that can be RM without risk of disallowance (safe harbor)
  3. Special rules for buildings

The safe harbor amount is determined by whether you have audited financial statements. Consequently, if you have been debating the cost benefit of having your financial statements audited in past years, this regulation may provide the incremental benefit that makes an audit practical.

Larger companies may need to update their capitalization policies to accommodate income tax reporting. Additionally, deferred tax calculations (including unrecognized tax benefits) will change because of these regulations and the impact will likely need to be disclosed in MD&A if material.

If the incorrect deductions are taken, interest and penalties will accrue on the excess amounts of deductions. Moreover, you risk of audit can increase in the future.

SHAMROCK vCFO Services in Naperville, IL specializes in helping small and medium size businesses with strategy, taxes, accounting, and financial performance management. Steve Shamrock left big companies to help smaller ones energize the economy.