12 Days of SSAP: Research and Development Tax Benefits

Insurance companies often overlook another powerful tax savings opportunity because most do not believe they perform any qualified research and development (R&D). However, this cannot be further from the truth. In fact, software development is the most common qualifying activity for the R&D tax credit for insurance companies. The R&D credit offers many benefits including a dollar-for-dollar reduction of federal tax liability and state tax liability for the states that offer it. Most recently, the Inflation Reduction Act significantly expanded the tax savings opportunity to use the credits to offset current payroll tax owed for many start-up companies or businesses within the first 5 years of operations. Starting in 2023, the maximum credit amount that can be claimed against a qualified start-up company’s payroll tax liability doubles from $250,000 to $500,000 per year.

The two most common expenses we see insurance companies claim towards the R&D tax credit are a portion of employee wages dedicated to software development and testing and 65% of certain outside contractor development costs if paid hourly and if the work was performed in the US. In addition, there are certain material costs used for integrated hardware and software, as well as fees for using a cloud-based environment for development work, that can be included.

Eligible software activities we often see for insurance businesses generally interface with third-party applications as opposed to those used primarily for internal purposes, such as general administrative or human resource functions only. Development efforts should focus on designing, coding, and testing for new and improved products or functionalities. All that is required is that the activities meet the four-part test for software that is not used solely for internal purposes, such as general administrative or Human Resource functions.

Another provision under Section 174 allows a deduction of software development costs. One specific change for tax years post 12-31-2021 is the requirement to capitalize and amortize Section 174 research expenses over 5 years for domestic and 15 years for foreign expenses as specified in the  Tax Cuts and Jobs Act Revisions to §174 specify that software development costs are considered specified research expenditures (“SREs”) and subject to the new capitalization and amortization requirements. Under the new law, insurance companies engaged in software development no longer have the option of expensing these costs in the current year or capitalizing and amortizing a portion or the entirety of the costs for a minimum of 60 months over the useful life of the software. Instead, they must capitalize and amortize these expenses in the year they are incurred. To ensure you maximize software development costs and eligible activities available under Section 174, JLK Rosenberger has highlighted the key points from the IRS interim guidance issued in Notice 2023-63 and Notice 2024-12. A federal bill proposed, H.R. 7024, would allow for the opportunity to once again expense eligible R&D costs in the year incurred. Unfortunately, the bill is still working through the Senate and will require additional time before passage.