One of the key expenditures incurred during software development activities is employee wages.
What you may not already know is that, under Internal Revenue Code (IRC) Section 41, some wages are considered qualified research expenses, especially if the employee’s activities are for direct research, direct supervision or direct support of those performing research. For the development of software, especially internal-use software projects, high-level executives are often intimately involved in all aspects of the software development project – these projects are usually a part of a company-wide, mission-critical initiative.
Frequently, the Chief Information Officer (CIO) has direct input into new and improved technologies and directly supervises and reviews the activities of their software development teams. This is a highly compensated employee who is responsible for the IT strategy and the computer systems required to support a company’s business objectives and goals. To this end, the CIO will have performed qualified activities with eligible wages for the R&D tax credit.
Tax Court Case In A High-Wage Qualified Research Expenses Claim
To illustrate this point, a recent tax court case involving Estech Systems, Inc. (ESI), a designer of telephone systems for small and midsize businesses, clarifies what wage expenses constitute qualified research expenditures for purposes of the R&D tax credit.Upon audit, the IRS challenged ESI’s credits, arguing that the wages of ESI’s chief executive officer (CEO), Eric Suder, were unsupported and unreasonable as qualified expenses. Generally, the wages of employees engaged in qualifying research or directly supervising qualifying research are includible for purposes of the R&D tax credit.
The tax court examined whether ESI adequately substantiated Suder’s qualified expenses under IRC Section 41 and whether his wages were reasonable under IRC Section 174. Ultimately, the tax court held that Suder performed qualified research activities, and furthermore that ESI adequately substantiated those activities.
Wages accounted for almost all of the expenses ESI claimed, with two-thirds of those wages attributable to the CEO. To determine whether his wage was reasonable, the tax court looked at several facts and circumstances, including Suder’s:
- Qualifications and work duties
- Wages relative to the company’s income
- Wages as R&D expenses
- Compensation compared with those of other company CEOs
How To Cover Your High-Wage R&D Expense Claims
If you’re considering claiming R&D tax credits for high-level executive wages, keep in mind that credible testimony is a valid method for providing adequate documentation for:
- Claimed qualified expenses
- Senior management time spent attending technical meetings
- Reviewing and signing off on design and functional specifications
- Managing the software development project
An experienced R&D tax credit consultant is adept at combing through documentation and relating it to similar cases as above to determine the eligibility of your wage expense claims to pass an audit and capture the tax credits.
Ready to learn if your executive wages qualify for R&D tax credits? Speak with a tax expert at CTI.
