Comment by scrozier
3 years ago
> 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.
>> Not exactly. It's a well-established accounting principle that you capitalize costs that provide a benefit over multiple years.
OK, so lets flip this. I'm a founder working for free, as many founders do. We code on nights and weekends and produce hundreds of thousands of dollars of capital value. If the business doesnt work out, can I claim all this as a loss?
We cant have it both ways, can we? So I should be able to take losses on these hundreds of git repos I have with thousands of hours of unpaid work?
Catch 22: if you claimed the loss for the value of the hours worked, you would also end up having to pay income tax on the value of hours worked.
Paying yourself is a lose-lose game.
I've got lots of 'failed' projects I've spent obscene amounts of time on. Where's the Lambo dealership?
Technically, I would assume that you probably can claim this as a capital loss if you have actually realized a loss (eg you spent money on software related to the business or something), but those are capped at $6,000 a year. Those expenses previously could have gone on a schedule C, though.
So are the taxes capped also? Didn’t think so.
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Founders work for free because they're investing, taking a risk like all investments. If they lose the bet, they lose. No harm, no foul. That's true of any investment you and I make. People lose money on investments every day.
There are a lot concepts being not very well defined here: employment, investing, taxation, salaries. It's not all one thing.
What is it that you think "we" are having both ways?
> And now the government is pushing back, not without reason.
Is it? Seems like lawmakers just messed up in reaching an agreement to extend something that is usually extended. Typical congress games.
From light reading, Republican leadership seems to be the main blocker since extending the provision has bipartisan support. You would think that extending this and child tax credits would be no-brainers for Republican leadership, but here we are.
That could well be. But maybe it's not so obviously a good thing as it may sound to startup ears. Matching income and expenses is a pretty good way to keep your financial head about you.
> That could well be.
No, it is. That's literally why this happened, it was used as a bargaining chip/to buy time and they never cleaned it up. It's not supposition or a guess, it's the stated intent and consequence.
> it's not so obviously a good thing
Let's say you earn a million dollars before salary and you have 10 engineers working for you each making $100k. You pay out your salary and have $0 profit at the end of the year.
With this change, you are taxed as if you made $800k profit, so unless you've got a couple hundred grand in your bank account this is easily enough to bankrupt a business and put those 10 engineers out of work.
It would be one thing if the $800k was in the bank and this was Hollywood accounting to make it seem like it's not profit. But this is money that was paid to employees and now the business is expected to pay taxes on it as if it was never paid. It's absolutely farcical how anyone could look at this and not see it as ridiculous.
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> And now the government is pushing back, not without reason.
What reason is that? Increased tax revenue (in the short term at least)? Because if there's no difference in the long term then it seems pretty dumb to inflict financial turmoil for no net gain.
Well, yes, increased tax revenue, of course. There may be no/little difference in the long term; that's over my economics pay grade. It seems like the model of raise a lot of money, spend a lot of money, expense it, pay no taxes, then go bankrupt is a pretty straightforward way there might be a difference long term. And that's a very common scenario, I think you'd agree.
> that you capitalize costs that provide a benefit over multiple years
Do you see a difference between software development in a consulting business model (instant one-off benefit) and software development in a saas product business model (benefit over multiple years)?
> There are good arguments on both sides. Can you provide the good arguments for capitalizing software development costs and not expensing it?
Can you explain the reasoning of charging taxes to a company that has revenue beyond merely 1/5th of its expenses (actually 1/10th in the first year, or 1/30th for international operations) and hence still heavily investing cash?
> Do you see a difference between software development in a consulting business model (instant one-off benefit) and software development in a saas product business model (benefit over multiple years)?
Yes. Not sure what that has to do with this discussion.
> Can you provide the good arguments for capitalizing software development costs and not expensing it?
Yes. The well-established accounting principle of matching income and expenses.
> Can you explain the reasoning of charging taxes to a company that has revenue beyond merely 1/5th of its expenses (actually 1/10th in the first year, or 1/30th for international operations) and hence still heavily investing cash?
Yes. See the answer to your second question. Companies often have to make investments. If they buy a Big Machine, they don't get to write it off in one year. There's nothing nefarious about amortizing costs over their useful life.
> Yes. Not sure what that has to do with this discussion.
Because the law seems to be very strict that all software development should be capitalized. So would you suggest to split the revenue recognition depending on the corresponding business model of the product corresponding to the software development?
> If they buy a Big Machine, they don't get to write it off in one year. There's nothing nefarious about amortizing costs over their useful life.
It seems the capitalization of the wage of a software developer is being defended and put equal to the capitalisation of the cost of a Big Machine. I still see an unfair difference made in the reasoning. Let’s take following example
* Software developer has a wage cost in year 1 and builds a SaaS tool in year 1. The developer’s useful life w.r.t. the incurred cost is indeed 1 year and the revenue generating period of the product is 5 years.
* Big machine (crane) has a purchase cost in year 1 and builds a warehouse in year 1. The crane’s useful life w.r.t. the incurred cost is 5 years and the revenue generating period of the product is 30 years.
It’s being claimed that both the software developer's first year wage and the Big Machine purchase cost should be capitalised over 5 years. But that’s comparing apples with pears: either both should be capitalised over their own useful life w.r.t. the incurred cost (1 year vs. 5 years) or both should be capitalised over the revenue generating period of their product (5 year vs. 30 years).
Three other thought experiments:
* You should capitalize a crane when you buy it and you should expense when you (properly w.r.t. accounting principles) rent and use it for a year to build something. But when you rent a software developer (= hire) for a year to build something, that should be capitalized?
* When the crane is being sold or breaks down, you recognise a gain or loss and the capitalization stops. When the software developer leaves the company, is the capitalisation of the developer’s wage still continuing?
* I come work for you for the next five years as a software developer, but you have to pay me my wage immediately for the upcoming five years. Also you have to buy a GPU server that I will use to build my product and that will supposedly last 5 years. Are you capitalising both my cost and the GPU over 5 years? Or will you be capitalising my cost way longer than the GPU, even both I’m gone after 5 years and the GPU broke down?