Software firms across US facing tax bills that threaten survival

I understand the arguments for it, and maybe even on net it’s beneficial because it prevents other bad things from happening, but the amount of byzantine dysfunction that’s downstream of the United States Senate Filibuster rule is really something to behold.

Thank you for providing the actual political context. It is much more helpful to know who did this and why then to complain about an amorphous and unchanging "Congress".

The thing that is most striking to me about your explanation is that the change was made six years ago; it seems that anyone responsible for a company's tax position and cashflow (CFO, accountant, etc) should have been planning for this between then and now. Much like the SVB panic, a great deal of this seems to be people running companies without either paying attention to things that could have a significant impact, or hiring someone who does.

I don’t know why you’d think it was an oversight. After all, they pushed SALT, which raised the taxes of any homeowner living in a high cost of living state, and further transfers wealth to flyover country and the south.

It gets worse, we do not reach true majorities in the House and Senate until 2030. Thus until then budgets get passed under budget reconciliation.

This whole thing sounds so shady to me, can't believe this is how they are running a country.

[flagged]

[flagged]

You know, this is pretty clearly the right answer. Software developer salaries are ordinary business expenses. There’s some alarming language in the section about deductibility of R&E expenses, but core business functions aren’t R&E.

Really perceptive comment.

From the Section 174 text:

    26 U.S. Code § 174 - Amortization of research and experimental expenditures 
    (c) Special rules
    (3) Software development

    For purposes of this section, any amount paid or incurred in connection with the development of any software shall be treated as a research or experimental expenditure.

https://www.law.cornell.edu/uscode/text/26/174

To me it doesn't sound like classification is discretionary to me, or that splitting semantic hairs will prove effective (IANAL).

(Additionally, the R&E classification is different from R&D)

How do you explain the CBO scoring?

That sounds pretty horrible. Am I correct in assuming though that once you get over the five year hump, you're OK? Also wouldn't startups mostly be paying devs out of VC funding rather than revenue the first five years?

Software has a long life, like buildings and whatnot, so that is likely why it is singled out versus the office manager.

If you buy a building, you can’t depreciate the whole thing instantly, you do it over the life of the building.

They get acquired by companies that have unused deductions. That is how monopolies form.

After 5 years dont you end up with some "finished" R&D project that then can be later amortized, over say next 3 (or 5 years), so you reduce your tax base by those 2 million later on?

Software was targeted directly because they couldn't agree how to change 230. There are those who want to punish the "tech" people who were "censoring" things they didn't want censored. It was designed to be tactical retribution.

When you lay it out like that...

Feels like this is just a move to stop companies from gaming expenses to avoid profiting. Piercing the corporate veil, if you will.

Yup, I am screwed because I got an SBIR grant in 2022. The default indirect cost rate is ~30%. In this new scenario, it should be something more like 60%, which reduces the usable funds that can be spent on actual development (IF you can even get a high rate like that approved by the govt agency)

EDIT: By "screwed" I mean that I'm facing a $100k personal tax bill because the company is an LLC taxed as an S-Corp. You can say all you want about lack of planning, etc, but the reality is that many times very small business do not have the budget for a high-end business accountant on retainer. If I were to try to "plan better" to avoid this situation, I would have just not written the grant or tried to do any of it and gotten a FT job or something instead. It's an innovation-killer.

They are indeed hard hit as well. SBIR grant awardees sent their own letter to Congress about this a month ago: https://sbtc.org/sbtc-letter-to-congress-on-sec-174-tax-conc...

> I doubt most grant proposals have a 20-30% haircut built into the budget like that...

Most university research budgets do yes, and actually more than that.

It is insane.

If they don’t fix it a lot of companies (and their owners) are going to go bankrupt.

This is a topic I know very little about but doesn't this type of "absolutely insane" thing happen to other small businesses due to estate taxes too?

For example:

    - Your uncle owns a farm for the last 50 years
    - Over the 50 years the farm's land value has risen to $1,000,000
    - The farm itself only generates $20,000 a year in profit which is spent on living expenses
    - Your uncle has no savings
    - Your uncle dies
    - A 40% federal estate tax is applied onto the farm's current value from your uncle's death (state taxes might also be added)
    - Whoever owns the farm is now responsible for coming up with $400,000+ or you're forced to sell the farm to cover the tax bill

I might be butchering this so please correct me if I'm wrong but this feels like a system that helps larger companies because it prevents a smaller business being able to exist multiple generations.

It was written to fuck over smaller companies. That was the point of it.

Is the IRS willing to let companies make payments of the tax over years? Would would the IRS want to put companies out of business?

This is a complicated question.

On the one hand, Section 174 clearly stipulates: "(3)Software development For purposes of this section, any amount paid or incurred in connection with the development of any software shall be treated as a research or experimental expenditure." [1]

Section 174 R&E expenses are much more expansive than what qualifies under the R&D tax credit criteria. This article has a rundown of some of the activities included in 174. It's well beyond software or salaries -- it also includes things like market research. It also includes any expenses in connection with R&E, so for example time using a server for new features or new products would have to be amortized but maintenance (bug fixes) wouldn't. Even if a company files for R&D tax credits, they won't be able to offset this increase. [2]

Lastly, since Congress was widely expected to revert this before it took effect, the IRS didn't issue full guidance on how to implement it. They've never had to define software development before, but the interpretation that Big 4 accounting firms are taking is that it covers new products AND new features on existing commercial products, but not straight maintenance.

[1] https://www.law.cornell.edu/uscode/text/26/174 [2] https://www.forbes.com/sites/lynnmucenskikeck/2023/03/24/fiv...

What would a software developer do that isn't research or development? Maybe my understanding of "research and development" is wrong. Is there a formal definition that I can go by?

"I haven't yet gotten the answer for this each time this issue comes up."

Asnwer: It's not mandatory.

Honestly this whole thing looks like a huge tax loophole, now being closed. I don't know of any jurisdiction (apart from the US, apparently) which allowed 100% non-amortized tax credit for loosely defined R&D salaries. No wonder everyone and their dog started software companies in the US.

Do you have a source for this? The law seems pretty clear to me:

> ANY amount paid or incurred in connection with the development of ANY software shall be treated as a research or experimental expenditure.

https://www.law.cornell.edu/uscode/text/26/174

> I think the average engineer spends less than 20% of their time on "true" R&D

Based on all of the items in #2, the average software engineer spends close to 0% of their time on R&D - with rare exceptions for those working on cutting edge tech, in research roles or maybe super senior engineers figuring out how to solve complex technical problems

The rest of us just write code and sit in meetings

It would be interesting if this reintroduced "10% time" with strict wording about not working on R&D in your 90% time. Just to simplify the labor involved in calculating it.

You’d expect to run into transfer pricing issues if did that, unless you’d already structured your company avoid those problems. This problem here, and many others like it stem from the fact that corporate tax is a stupid concept. It doesn’t generate any additional tax revenue, because any tax that is paid as corporate tax will simply be used to offset taxes that would otherwise be paid as income tax. It also simply preferences operating models which are more accessible to large companies, disadvantaging SMEs. Any company can theoretically choose to not be profitable, by reinvesting all of its profits, and investors typically don’t care if their value is returned via growth or dividends. But many SME operators do, and the accounting and compliance costs associated with that place a higher burden on SMEs. But the whole debate around the topic is muddied by people who intentionally misrepresent how these systems work for their political gain, and their followers who don’t understand how these systems work (until some stupid change like this affects them, and the stupidity of the system is made clear).

In Canada, qualifying R&D spending generates a tax credit that can be worth 60% of engineers’ salaries. In other words, a company that spends $1M on engineers in Canada not only writes off the $1M in spending, but also gets a credit of $600,000.

Fine print: this is only available to Canadian-controlled entities. Foreign-controlled entities can claim R&D tax credits as well, but the rate is far less generous.

Canadian corporate taxes are quite a bit higher than in the US - 33% vs 21%. So not an easy decision...

As it relates to developer salaries, you don't have an option to decide if you're going to capitalize or immediately expense. With this bill, you must amortize over five years.

You're talking about deciding whether or not to capitalize a laptop, a piece of equipment, a vehicle, etc, and over what period. There's lots of guidance for that. This is very specifically affecting the salaries you pay software developers.

It benefits VCs because it makes it impossible to sustainably self-fund a business.

Startup subsidy?

This seems to be penalizing competition and new competitors, for literally no reason.

No

Year one: You go broke. Everyone loses their jobs. You file for bankruptcy. Game over. There is no year 5.

That’s if you could have afforded to pay the tax on the $2,000,000 of phantom profit you had until this point, which no one can.

You don’t get that back unless you somehow fire everyone so you can offset income and expenses without more amortization.

The lack of specificity in your little table should illuminate for you why this is such a complex issue to comprehend. I understand there is some fictional, meaningless interpretation hidden inside your head where that table is "right," but for all normal interpretations, it's wrong.

Unconstrained growth is not tolerated anywhere else, but somehow people bend over backwards to explain how actually any constraints on business growth are Very Bad And Evil.

I have been thinking this for a while. Corporation tax creates so much work, and it would be better to tax certain inflows of money.

So my salary is taxed; my dividends are taxed; my purchases are taxed with VAT, that sort of thing.

Stop making companies employ armies of accountants to figure out all the tax credits/implications/corporate structures etc so the government doesn't take too much.

It doesn't even out if the company keeps growing - if your headcount is growing 50% per year you can have very significant tax drag.

^^ This is the core issue.

The law has a call out that software development costs are all R&D now. So yes according to my understanding (as one of the signers) and those who have written about this as well.

The accounting standards forbid expensing things that should be capitalised, and if you go ahead and do it anyway your investors will wonder why your accounts show you have no assets.

It doesn’t matter what you label an expense. Accounting principles and regulations decide what category expenses fall into. That’s a major reason CAs exist, to ensure that your expenses are correctly categorized.

I am not an accountant, but I took 2 years of accounts, and learning to categorize expenses correctly was probably 75% of the classes.

So doesn't this just incentivize replacing FTE's with contracting firms when starting up?

Yes.

yes.

It’s a cash flow issue, not a tax rate issue.

I don’t think you understand amortized expense accounting and income tax, you have a line item labeled tax on revenue.

What you are showing is cash flow not the income statement and also you don’t understand the tax is based on the income statement and not the salaries being paid or the revenue, but the calculated income for tax purposes.

In the 2nd year it will be 2/5ths, $200K, amortized expense of prior year plus current year, assuming same numbers, and by the 5th year would be full amount.

Your cash flow is correct and yes it becomes -$200K which is really bad. However I wanted to clarify the mechanics.

Yeah that would be the cash flow, my example was taxable income. But yes, that's the whole problem!

The answer is simple: you just cut the developers' salaries to minimum wage. They'll all be happy to just have a job and will stick around, right?

Agreed, options are great! Unfortunately this bill removes all options.

Also operating losses can be carried forward and used for 20 years, so recognizing a big loss in a single year isn't really that bad.

> Isn't this all referring to the "R&D tax credit"?

No. The terminology is confusing. Section 174, specifically point 3, classifies software development as R&E as of 2022 and requires amortization over 5-15 years. This prevents software engineering salaries as a standard business tax deduction. This has nothing to do with the R&D tax credit (section 41).

> Isn't this all referring to the "R&D tax credit"?

No, it is not.

Because you don't stop paying developers starting the second year?

> Couldn't they borrow the money for their taxes against future profits?

In theory, but good luck getting a loan secured against IP for a reasonable rate.

The change isn't really sudden and honestly I have a hard time having sympathy for those firms that were caught unaware. This provision was in the law since 2017 - anyone taking a chunk of VC money (including the VC lending it) should have been well aware of what would happen if Congress did not strike it before it took effect.

Honestly this is a bit like SVB all over again - poor management, in this case not knowing or understanding critical tax laws. And if you did know, shame on you for not contingency planning for Congressional ineptitude.

The R&D isn't a pure expense, it typically has a result. Say you spend a million dollars developing a widget and then sell it for 10 years. The money spent in year one results in multiple years of income.

I don't have a strong enough understanding of the change to really have an opinion, but that seems to be the clearer description, the R&D spending is being treated as an investment in the business (which it probably is) that results in capital (who knows if that is true).

One reason is that sometimes companies claim money from the government for their R&D spend (some sort of scheme by government to incent R&D spending, presumably). In that event the government wants to prevent companies from gaming the system by simply saying that they spent all their profits each year on R&D. So rules are created that say you have to spread the spend over N years for tax purposes. Same as asset depreciation -- you're generally not allowed to depreciate a large asset in one year.

At the same time, wouldn't it discourage reducing headcount (or at least headcount expenditure) for companies with roughly flat or linear revenue growth (see all the big tech layoffs), because you'd be paying more in taxes next year, etc. ?

edit: never mind, I completely misunderstood. It really only seems to harm "moonshot" companies; big tech and sustainable companies appear to be largely unaffected. If anything they may benefit as it will be more costly for upstarts to try competing

Assuming everything stays the same, this rule actually results in marginally lower tax burden (since progressive income tax means that 5 years of tax at $800k < 4 years of tax at $1 million). Assuming that it changes, no. In a worst case scenario, you may be paying a lot more if you do most of your development in a peak year and then lose the revenue stream later.

It's not up to you to categorize them one way or another. This law mandates that they are r&d and thus amortized.

This is backwards. Capital expenses are amortized because you purchase an asset that will give you value over multiple years. So, for example, if you buy an office building, you amortize the capital expense.

But what this does is says that if the product you created is an asset, the salaries that go into creating that asset should be treated as if it were purchasing that asset. The office building equivalent would be the builder having to treat the salary it paid its labor as a capital expense and amortizing it.

That sounds beyond insane.

That being said, it’s not a material change, if phased in properly, so companies have time to spread their expenses over a period of time.

But it looks like neither was this planned for (not surprising because it’s ridiculous on its face), nor does the legislation phase it in a manner that can be properly absorbed.

In practice companies will get hit hard the first year, but save the equivalent amount over the next 3-4 years. So after 5 years it will be a wash (ignoring the time value of money…factoring in that makes it a loss, but not as much of a loss). The problem is that it will create tremendous cash flow problems as 5 years of tax is paid in 1 year.

How closely did you read the line items?

In the example given they received a revenue that covers the entire cost of the software. The problem is that they then used that revenue for payroll which would be fine previously as if you make $X and pay $X in payroll then you pay ($X - $X) 0 in taxes and there isn't a cash flow problem.

To stick with the apples-oranges lathe example. Imagine GM got a loan of $1M for the lathe and they can only depreciate 1/5 the cost of the lathe. So come tax time, GM has to pay taxes on their 800K of "profit" since they can't fully count the cost of the lathe against the loan.

It might be fine if that's how it long had been, maybe. What's definitely not fine is the sudden change of rules that an entire industry had been relying on for all their expense planning.

The key problem here is that for 70+ years companies have had the option to amortize or expense these costs. This change was made as an accounting sleight of hand to make the 2017 tax cuts look paid for over a long-term basis, but Congress never intended for this change to take effect. They know it isn't good tax or economic policy.

So now small businesses and startups are being thrown into crisis because Congress has accidentally implemented policy that they haven't gotten around to fixing.

One potential difference is that for many things that are capital expenses (a building for example) a business is likely to take out a loan in order to buy it, so they don't have the full expense up front. A bank is probably not going to loan you money to pay your developers at the same terms they will loan you money to buy a building.

It really depends of your business. Sure if your are a SaaS company, SAP, Google,... that's the case.

But if you are a small shop that build software for other companies, it isn't. You write the software, get a one off paiement and you'll not be able to get more revenue from it in the future outside of a possible maintenance contract. You can't resale it to someone else.

To summarise, the work of many software companies is akind to the work of design office : you do R&D for someone else. The amortization will have to be done by your customer, not by you.

... growing firms are also penalized. Also, if a company goes bankrupt (like the majority of companies), those last 4 years of amortization just go into the government's pocket. Even if you could ignore the time value of money, it doesn't actually even out over the long run.

> Assuming 1mm stays the same YoY in 5 years

That's a pretty big assumption.

But the first year is the hardest...

Why are you only considering the first year? My company has been around almost 20yrs and is impacted. There's no years since founding in any part of the calculation.

As long as you never grow.

Yes, you're correct.

Not an accountant But I think, they are thinking that software devs should be consultants ( unless they are researches doing something very risky, something that may not work (from technical not business sense))

This way, they are an expense to the corporation, and each one of the consultants pay their own income tax.

In that way the corporation building software for sale/SaaS is treated the same way that a corporation that's buying and then renting out real-estate, for example.

It's not a big deal because this change affects very few companies outside of Silicon Valley and it only affects companies at the start of the R&D process.

After 5 years, the tax impact evens out to be the same as currently expensing R&D salaries.

And generally, software companies have gotten the benefit of the R&D credit even for things would not have qualified for the R&D credit if it had not involved software, so this change was merely seen as correcting a tax loophole that the software industry has been exploiting (and arguably abusing) for several decades.

Huh? It's not about startups. It's about small software businesses that were moderately profitable yesterday and are potentially out of business today.

This has nothing to do with year one though. This is hitting companies that are in year 5, 10, 20, etc.

If you were running a small software company that make 2m in revenue and puts 200k to the bottom line, your business no longer works.

Unfortunately, the Government of the United States disagrees with you.

If you make a million and pay a million in salaries, you have no cash left, right?

But! You get to pay taxes as if you made 800k in profit. So lucky you, you have zero dollars and now you get to pay 240,000 in tax (800k * 30%) to the government.

You're now 240k in the hole. Game over, no year two, three, or four.

This doesn't affect venture funded companies as badly because they have millions in funding and they can ride out the amortization. It does, however, affect bootstrappers trying to start a thing. Perhaps you could call them small, indie hackers?

If anything, HN should not be cheering this law as it doesn't affect large incumbents and those with millions in VC funding, but crushes the little guys.

How can you grow your R&D team when you’re no longer in business because your tax bill is more money than you have? It makes zero sense.

It's the opposite. It disincentivizes growing all software dev (not just R&D) by front-loading taxes.

Let's say you have to pay 30% tax on 800,000 of profit, so now you're 240k in the hole. That's your year one! If you don't survive to take the future deductions it's kinda moot right?

Only a small portion of activities count as R&D for R&D tax credit purposes. R&E is a much bigger category and where the problem lies. This write up has a good graphic showing the magnitude (scroll halfway) https://www.striketax.com/journal/tcja-and-the-resulting-tax...

It seems like a wise idea then for Congress to allow small businesses to keep this tax credit.

Would you recommend to keep on with favoring this accounting trick for fairness because previous businesses took advantage of it? If so, how/when should the legislator changes laws when needed?

> general public

Not sure what’s your definition, maybe “non-startup founders neither investors” ? I work in startup since a couple of years and all my employers did declare me as r&d while we where only implementing react or so without any “research” difference than a cabinet maker building a piece of furniture. This drives me nuts because I don’t contribute to my country tax while my income is on the very upper side comparing median.

Creative =/= Research

My guess is they'll treat it like repairs and improvements on physical equipment. Fix a broken calculation, that's opex. Add an API for better Google integration, that's capex.

The average roof has a lifespan at least an order of magnitude greater than a k8s cluster. Most roofs being put on today will outlast k8s itself.

Software is a liability, not an asset. Treating the construction and maintenance of this horrible liability knows as “code” is a complete misunderstanding of what software actual is.

> the k8s cluster will be around for awhile.

without someone maintaining it, it would probably fail by the end of month. That's not considering the constant changes going into it.

How is fixing a bug in the interest of a new product?

The IRS isn't doing this. Congress did it, because it's an accounting trick that lets them say something costs less than it actually does, because all of Congress' budgeting is on decade-long horizons, and they factor in theoretical wage/revenue/profit growth, so them front-loading the same tax receipts allows them to very easily lie about the actual cost of programs. They can pull 80% of the tax receipts from made up figures a decade from now into their government revenue calculations.

They're doing it this way because in the public eye big startups that write off salaries as tax expense look like tax avaiders.

In reality it will just punish bootstrapped companies.

It's not GAAP revenue until the product is out of your hands and in a usable state.

So you can drop the license in an envelope and recognize the revenue immediately, but only if the recipient could have used it if they'd grabbed it from the mailbox.

If the license isn't usable for another month, you can send it to the customer, they can pay for it, and you can even spend the cash, but the payment sits on your balance sheet as a liability until the moment the license becomes valid.

Where is the line?

> The problem is that this tax change is artificially inflating profits

Not exactly. It's a well-established accounting principle that you capitalize costs that provide a benefit over multiple years. Depreciation is an easy-to-understand example. It's more true that the historic practice of expensing R&D costs was artificially inflating costs.

What the tax change is doing is forcing amortization, which, for early-stage companies is difficult, because they have depended on expensing early and recognizing income later.

It's a difficult issue. There are good arguments on both sides. But it sounds like this was a surprise, which is surely not optimal.

fwiw, when I was running start-ups (80s/90s/00s), my recollection is that we amortized our software development costs. I guess this got turned around by the rise of the sophisticated startup world, with more accountants, lawyers, and lobbyists. And now the government is pushing back, not without reason.

I've seen previous discussions about this on HN but there seemed to be disagreement about whether this change required developer salaries to be treated as R+D or only allowed it.

If this is really the way it works, defining some salaries as necessarily not being deductible from revenues, then it makes no sense for multiple reasons.

First the developers are still paying income tax on their salaries so that money is getting doubly taxed in the year the revenues are received.

Second the government generally seeks to encourage employment. This would have the exact opposite effect because any employee you hire who's doing software development would cost you (1 + 4/5) times their salary in the near term.

I wonder how much of the downturn in tech employment this year is being caused by this.

The burn cash but not necessarily profit. If they built the software in 1 year for 1,000,000, they would carry an asset of 1,000,000. They burned 1,000,000 in cash but have a 1,000,000 asset. They had salary expense of 1,000,000 and revenue of 0. Say they make 300,000 in revenue for the next 5 years based on that software. That means they would be able to expense $200,000 against the $300,000 in income, paying taxes on just $100,000 in income each of those years. At the end of that time the asset has zero value.

The other option is they take a 1,000,000 loss that first year, and then pay tax on all $300,000 for each of the succeeding years. Either way, at the end of six years, There was $1,500,000 in revenue and $1,000,000 in expenses.

As far as the treatment of bug fixes, the rules around improvements and repairs probably cover that. If you fix a bug like a bad calculation - that's probably opex, like replacing a part on a machine. If you add a feature that extends the life of the product, like adding an API for outside developers, that would be an improvement and capitalized. This is like refurbishing equipment to extend its useful service life.

Not very familiar with the US tax system, but is there no option to treat "R&D spending" as a normal business expense, forgoing all R&D incentives or tax credits?

R&D = "research and development"

If what you are doing is software development then obviously it is a development activity that falls within the meaning of development for purposes of tax laws.

Software programming that does not constitute development, such as bug fixing, is not subject to capitalization.

Even if you have the cash, in a high inflation environment with higher costs of lending, paying tax on ~80% today and getting that tax back over 4 years, leads to indirect costs. Especially for startups.

>The issue here is in the way it is deducted.

The issue is that the rules changed. Businesses that relied on the former rules are now faced with a (possibly insurmountable) challenge to accommodate the new rules.

Washington loves to fiddle with tax rules, and lobbyists spend a lot of time and money encouraging it, but nobody can anticipate the ripple effects. It all looks great on CBO spreadsheets and congressional press releases, but the real-world impacts can be devastating.

I only hope they include some kind of small letter that the same person needs to still be employed to get the amortization - I think that's actually implied by it. The same way you got to keep a machine to keep deducting it. I think the gov't got fed up of the mass layoffs and this is how they are fixing it.

Assuming you had no other expenses the tax bill would be $168k on the $800k right? So what we're saying is a business with $1M each in revenue and salary expense would have an additional $168k in current year tax expense?

its like a weird inverse of paying quarterly taxes...the same goal - more of your money stays with the government longer

That's still taxed off profits, not gross.

I've been wanted to someday start an employee-owned, non-tech S-corp. However these changes are squeezing out small players.

"It will kind of even out over time, but it wacks new companies very hard."

Amortizing salaries seems really weird since they are recurring every year. After 5 years you can deduct your full salary expenses for that year. And after you have laid off everybody you can deduct for a few more years. Definitely makes it hard to hire a lot of people quickly if you don't have a ton of profit.

> R&D salaries

> For software companies, where costs are basically eng salaries,

... it smells like this might be fallout from mis-classifying workers and/or fudging categorization of labor for some benefit. Am I on to something?

My wife and I am getting a refund this year. Getting beat up in the business by inflation, all costs going up, and cutting income in half is not a great tax strategy.

It is going to make me push tougher time code tracking onto my developers. Fixing a bug is different than feature work is different than legit R&D that might qualify for the actual R&D tax credit. As if software devs love doing time sheets (not!) :-/

Software is an ongoing expense.

You spend a million a year each year you would have to break that out over 5 years

Also with the factory analogy - unreal is the car factory and you are like the worker who built the factory. (Asking out of ignorance) The workers wages are not treated as a capital to be amortized right?

>nor should the bug fixer.

Is a maintenance contract on a capital asset not capex?

If in your example you hired the construction workers as employees and, for what ever reason, kept them on the payroll, wouldn't you still be able to deduct the salaries you pay them each year ?

If not it seems like a colassal disincentive to employment, which is the opposite of the result usually sought by government policies.

How you raise money doesn't make a difference. What matters is how fast you can utilize your "engineering assets". More often than not startups don't sell anything (let's say "anything" is > 20% of developers' cost) in the first year, or even in the first 3 years. So for them it's not a problem, you simply carry forward losses until you start getting revenue, and at that point you have enough losses to offset those 80%. It doesn't work for companies which are lucky enough to make substantial (comparable to the salary) sales in the first year. It's like Ford built a new factory, made 600,000 F-150 and sold them and the factory is basically gone in one year, there is nothing left. Doesn't happen with real factories though and usually doesn't happen with startups, but there might be exceptions.

Companies don't have a choice. The law now requires amortization of software development expenses. Even companies that don't claim R&D tax credits are affected.

My apologies, I was a little outdated. Unfortunately can't update the previous comment. What I said was true as of 2017, when the USA had a corporate tax rate of 39%, which ranked third highest in the world.

It was changed to 26.8% by the Trump tax cuts, which ranks 81st in the world. But that's still higher than 144 countries, including Switzerland, Finland, Sweden, Denmark, Norway, UK, and Spain (just to name a few).

not only is this completely wrong, but you aren't taxed on assets, and capital has nothing to do with it either.

assuming you meant revenue and income, your example actually perfectly illustrates the problem. Company A has $1MM in revenue, spends $1MM on SE salaries and is taxed on $800k income. Company B has $1MM in revenue, spends $1MM on some AWS db service and has no income to be taxed on.

Doesn't Company A also have a DB worth $1 million? Or are you simply referring to the way these things are accounted?

By the founders definitions? At least 90 percent of the taxes we pay are not fair.

Any tax others have to pay, that I don't.

Whatever the consensus is.

No tax is fair. They're all involuntary transactions.

The US is the textbook experiment which proves that even minarchy (a minimal government) can't work.

All form of governments, no matter how small, tend to grow into huge socialist monsters (the usa is the largest employer in the world, second only to China, maybe).

Even if that very first government was founded on not collecting very little taxes for this very reason.

Just to clear this up, this change is unrelated to if you've taken the R&D credit. You should take it as it slightly helps offset this change, but regardless the calculation applies to dev salaries and costs without regard to if you've actually taken the R&D credit.

Section 174 intro: "In general in the case of a taxpayer’s specified research or experimental expenditures for any taxable year".

Note limiting phrase.

Section 174 later: "For purposes of this section, the term “specified research or experimental expenditures” means, with respect to any taxable year, research or experimental expenditures which are paid or incurred by the taxpayer during such taxable year in connection with the taxpayer’s trade or business."

Note the "in connection with the taxpayer's trade or business" and look up the definition of that phrasing versus "carrying on" business and compare to Section 162. (e.g., Snow v. Commissioner of Internal Revenue, 416 U.S. 500 (1974), Cantor v. Commissioner of Internal Revenue, 998 F.2d 1514 (1993), Scoggins v. Commissioner of Internal Revenue, 46 F.3d 950 (1995))

Section 174 later: "For purposes of this section, any amount paid or incurred in connection with the development of any software shall be treated as a research or experimental expenditure."

Note the limiting phrase.

Ultimately we need guidance from the Service but the above are (possibly aggressive) readings some CPAs are taking.

> See c(3). Any software development is unambiguously R&D.

"For purposes of this section" to me means you don't have to justify software development as R&E if you define that software development work as R&E.

Being pedantic, but it's R&E not R&D.

Sales/VAT are regressive, so if by politics you mean "not hosing the already hosed (the poor)", and by most economists you mean folks from the Austrian school of economics, then sure.

Apparently the right number is 90% of 21+10%, because amortization starts at the midpoint of the first year. (If you take authoritative tax advice from me you will totally go to jail.)

Not research and development in the traditional sense which was tied to the creation of a new product, drug, etc. It was intended to offset the cost and risk of invention.

I would not describe what most software engineers do as invention.

Applying this broadly to most software engineers, many who are now more akin to digital plumbers than research scientists, was a lucky break for however long it lasted.

To be fair, software development in 1954 is not software development today. It's less pure research. It's more akin to building the electrical infrastructure you need for a business. Even though I see the logic of treating software developed as a capitalized asset, I don't necessarily think the outcome will be net good.

Something doesn't sound right about this. On what grounds did they not recognize your cost basis?

Edit: I'm guessing you acquired the crypto through some means that doesn't keep records/report to the IRS. In that case, what choice does the IRS have? You should never purchase an investment without looking toward the tax implications at the end of the year. It sounds harsh, but you should have known that claiming a cost basis you have no proof for would never fly.

Actually. For foreign expenses, the amortization period is 15 years instead of 5, so the cash flow problem is even worse. :-(.

Note that this is an infinity percent tax rate and mostly only hits small businesses.

The same is true for other things you amortize and those maintenance costs are opex. If you don't change the oil, filters, spark plugs, etc. on your delivery trucks, they will break down before the end of their service life. Stale is not the same thing as useless. You might get bored by a game, or find the interface "old", but in enterprise environments, 10 year old software is very common. Heck, 90% of your transactions run on a platform first developed in the early 1960's.

The 5 year is arbitrary. Arguably, software doesn't really break or wear out, so the service life is arbitrary. (That's not to say that the OS it's running on doesn't break it during an update). 5 years matches the life of the capitalized equipment on which it runs. I don't have any insight as to the debate around 5 years, but my guess is computers are a 5 year asset.

My guess is the rules apply from other assets, where fixes to bugs and minor updates are opex as maintenance costs. If you make a major change that extends the life of the asset, such as remastering a game or refreshing the UI, or adding a feature, might be capitalized. This would be like adding a lift to a delivery truck or replacing the engine to extend its life.

There are a few tests for whether or not something is capitalized.

First, the revenue is earned in future accounting periods. For example, you buy a delivery truck. You expect to earn money over several years with the delivery truck. To match expenses with the revenue generated, a portion of the expense of the truck is allocated to each accounting period. If the revenue is in the current period, then there's no reason to capitalize. For example, fast food worker's wages are not capitalized since the revenue is in the current period. The warehouse construction worker's salary is capitalized int he cost of the warehouse because it will earn revenue for several years.

Another test is if it's assignable to the cost of the asset. The CFO's salary isn't capitalized as part of the investment (unless the company literally does nothing else), because there are a lot of projects and it's hard to specifically assign. Selling expenses aren't capitalized because 1) the asset is complete and 2) they are assignable to the sale and not the cost of the asset. Other costs to acquire the asset, such as delivery fees, installation fees, insurance, etc. are capitalized.

Do you own the asset? If I hire a construction company to build a warehouse, they hae nothing to capitalize since they don't own the asset. I do.

And material. If I have you write a shell script that we'll use for the next five years to copy backups between our servers and Azure, and it takes an afternoon, we don't capitalize that. It's just not material.

If it's leased for 90/95% of the cost and for 90/95% of the useful life, it's capitalized. This prevents companies from treating capitalized costs as leasing expenses in the current period.

I think it was part of the horse trade for the 2017 tax cut?

Actually, not amortizing makes them seem more profitable. At the end of the life of the asset, the totals are the same. However, under one model you show a giant loss, initially, and then profits for the next few years. If I expense the $1,000,000 in the year of acquisition, and show a 1,000,000 loss, I then show my revenue as pure profit. Instead, if I have to amortize, I show no loss my first year (because the cost is on the books as an asset), but profit in future years only when my revenue exceeds 200,000 (1/5 the acquisition price). This is how all other assets that earn revenue over multiple accounting periods are handled. Why should Ford have to capitalize a welding robot, but not the software developed to control the welding robot?

Really, you've never seen a warehouse complex get added to, or a building retrofitted with new loading docks or refrigerators? Hospitals are notorious for growing like a friggin' plant. They just keep adding wings.

Hey, fellow business owner here, but I am just getting started; haven't made a sale yet and haven't "paid" myself anything yet.

I am a single-man business. Would your situation be better if it had just been you? In other words, was it the fact that you had that other employee that is going to cause you to shut down? Or would it have happened with just you?

Does it matter?

Congress doesn't need to be involved to screw over small businesses.

If the last few years have demonstrated anything, it's the government can freely destroy small businesses by forcibly shutting them down for completely intangible reasons without the slightest repercussion.