DEVELOPING SOFTWARE FOR LICENSE NOT ENOUGH FOR R&D DEDUCTION

Under Code Section 174, research and development expenses are immediately deductible when incurred in a trade or business. This provision will also apply to new businesses despite the fact that no trade or business was being conducted at the time, if there is a realistic prospect that the taxpayer will later enter into a trade or business utilizing the technology developed. If deductibility is not allowed under Code Section 174, the expenses usually must be capitalized into the cost of the developed technology and thus not available for immediate tax deduction.

David Saykally went into the software development business. His intent at the time he was developing his software was to license the software to a wholly owned company, which would use the software in its business. In 1995 and 1996, Saykally deducted R&D expenses of $68,000 and $1,422,000.

The IRS challenged the deductions claiming that Saykally was not going to use the developed software in his own business. The Tax Court held for the IRS, and the 9th Circuit Court of Appeals has now affirmed the Tax Court.

Therefore, software developers who incur R&D expenses for software that they will license need to be careful if they want to currently deduct those expenses. As noted in the Tax Court case, development for license is NOT necessarily fatal to a Code Section 174 deduction. In distinguishing Saykally's situation from that in Scoggins v. Commissioner, 46 F.3d 950 (9th Cir. 1995), rev'g  T.C. Memo. 1991-263, the Tax Court noted that a deduction was allowed in Scoggins even when there was a licensing arrangement because the taxpayer there still intended to otherwise use the developed technology in its own trade or business. Since Saykally had no intent to otherwise use the developed technology himself, no R&D deduction is allowable.

David M. Saykally, 100 AFTR2d Para. 2007-5250 (CA 9 8/16/2007).

INTEREST RATES FOR TAX OVERPAYMENTS AND UNDERPAYMENTS (OCTOBER 2007 QUARTER)

The IRS has announced the interest rates for tax overpayments and underpayments for the calendar quarter beginning October 1, 2007.

For noncorporate taxpayers, the rate for both underpayments and overpayments will be 8%.

For corporations, the overpayment rate will be 7%. Corporations will receive 5.5% for overpayments exceeding $10,000. The underpayment rate for corporations will be 8%, but will be 10% for large corporate underpayments.

Rev. Rul. 2007-56

WRITTEN PLAN REQUIREMENTS FOR DEFERRED COMPENSATION DELAYED UNTIL 2009

Employers regularly adopt plans or agreements to pay compensation to one or more employees at a later point in time. Usually, the employees don't want to be taxed at the time the agreement is entered into, but only when the compensation is paid (well, they probably NEVER want to be taxed, but clearly prefer waiting until payment at least). Various provisions of the Internal Revenue Code may affect the ability to "defer" income taxation on such compensation.

One of the newest provisions is Code Section 409A, which applies to nonqualified plans (that is, deferred compensation arrangements that do not meet the specific Code requirements for retirement/deferred compensation payouts). Under Code Section 409A , all amounts deferred under a NQDC plan are currently includible in income to the extent not subject to a substantial risk of forfeiture and not previously included in gross income, unless the plan (a) meets certain stated distribution, acceleration of benefit, and election requirements, and (b) is operated in accordance with these requirements.

In 2007, the IRS issued regulations under Code Section 409A that required that all plans be in writing and contain requirements provided for in those regulations. Initially, it gave taxpayers until January 1, 2008 to get compliant plans in place.

Acknowledging that this was too quick a deadline, the IRS has now extended the written plan deadline until December 31, 2008. Taxpayers have until that date to adopt a fully complying written plan if (1) the plan is operated in accordance with the requirements of Section 409A and applicable regulations and guidance through that date, and (2) the plan is amended on or before December 31, 2008 to comply retroactively to January 1, 2008. However, to use this extended time period, taxpayers must still comply with certain written designation of a time and form of payment requirements by January 1, 2008.

Undoubtedly, there are numerous employers who may have plans or agreements as to paying deferred compensation but who are not aware of Code Section 409A and/or its written plan requirements. If there is any question, such employers should consult with their tax counsel soon to determine whether they come within Code Section 409A, and if yes, to assist with the preparation of a complying written plan.

Notice 2007-78