Comment by givemeethekeys
3 years ago
I'll concede that my knowledge is incomplete.
In my experience the IRS isn't dumb or unreasonable.
The purpose of R&D tax credits is to stimulate R&D spending. It isn't to penalize you for ordinary business expenses.
The following two scenarios should compute the same way:
1) You operate a software services business. 100% of the development you do is for other people. You bring in revenue and pay your team, which is a straight expense. You pay salaries, and you get taxed on net income.
2) You run a software business. You hired engineers to build software. You sell it in some way to bring in revenue. You deduct your expenses, pay taxes on net income.
Now, our government has decided that companies should be rewarded for doing R&D. This means that, if you were able to demonstrate certain expenses as R&D expenses - you get to claim the R&D tax credit for those expenses. Maybe this is how some companies expense certain employee perks (massages, lunches etc..) that don't get accounted as employee compensation.
There seems to be enough confusion on how to claim R&D credits, that many companies don't even bother:
- https://taxfoundation.org/research-and-development-tax/#Eval...
You're mixing up two different things here. There is no reward for R&D under this rule change. If anything it penalizes R&D, especially in the case of speculative ventures (startups, new product development, and so forth).
The R&D tax credit is different from the deductibility of R&D expenses under Sec. 174. The deductibility of those expenses is what's at issue here. They were previously deductible, but are no longer deductible as of January 1st 2022, regardless of whether the taxpayer chooses to take the R&D tax credit or not. This is a change passed by Congress as part of the 2017 TCJA that went into effect in 2022. It is not the IRS's decision, though it is my understanding that they have some rule making authority about the specifics of the implementation.
Because of this, you are incorrect that the two scenarios you outline compute the same as of 2022. You are correct that they did compute the same before 2022, but they compute very differently now. Scenario 2 now requires that the software business amortize any costs associated with developing new software (engineer salaries, etc.) over 5 years, rather than deducting them in the same year they are spent. This increases the business's immediate tax liability while it develops the software, and also increases its tax liability in any other years that it creates new (and probably also improved) software.
Yeah, that interpretation of the rule change sounds very unreasonable to me. Employees are employees - plumbers, electricians, software engineers, hardware engineers, accountants... everyone's salary gets expensed the same.
Sure. I also agree it's unreasonable. But it's not an interpretation. That's actually what the rule is now unless Congress acts to change it!
EDIT: I wouldn't be surprised to learn that the IRS is not thrilled with the change either. It seems challenging for them to implement with software in particular.