Under IRC Sec. 41(b)(2)(A)(iii), the amount paid or incurred for the rental or lease of computers used in the conduct of qualified research can be included in QRE. The computer must be located off taxpayer premises and the taxpayer mustn’t be the operator or primary user of the computer. The qualifying amount must be reduced by the amount that the taxpayer (or any member of a controlled group of corporations or businesses under common control) received or accrued for the right to use substantially identical property.
In certain instances, cloud computing expenses related to software development may be claimed as a qualifying expense for purposes of the R&D credit. However, a thorough analysis and documentation of the specific expenses is required. Expenses related to file hosting, mail hosting, and other general activities will not qualify for the R&D tax credit. Additionally, the ownership and fee structure must be closely evaluated for purposes of the credit.
In evaluating cloud computing expenses, consider the following:
- Are the expenses directly connected to qualifying research and development (e.g. software development)?
- Are the expenses incurred for hosting software under development or are they incurred for hosting post-R&D software (generally non-qualifying)?
- Are the expenses connected to non-qualifying activities in addition to qualifying research and development?
- If the expenses are related to both qualifying and non-qualifying activities, what documentation exists to support a reasonable estimate of the qualifying amount?
- The language included in contracts with the cloud service provider(s) should be closely examined to understand ownership and fee structure.