Comment by sangnoir
3 years ago
Is it mandatory for software companies to classify engineer salaries as "R&D"? I haven't yet gotten an answer for this each time this issue comes up.
I know it used to be advantageous due to the R&D amortization period, and I feel this was abused in cases were there was effectively no research or development (in the traditional sense). How is your example materially different from a furniture shop that has similar revenue & salary numbers, but previously wasn't able to amortize salaries as "R&D"?
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...
> maintenance (bug fixes) wouldn't.
Link [2] lists activities related to software development and includes maintenance and debugging. As I understand it this is for the older #41?
• Programming
• Tuning and benchmarking of software
• Performing software maintenance and debugging
...
Am I understanding this correctly that there are two different things at play here: the Section 41 tax credit which works in the companies' favor by allowing them to deduce R&D expenses. Then the Section 174 that requires all expenses to be amortized and the big issue for software firms is that the definitions of R&D differes where it's narrow R&D for the credit, but very broad for #174, resulting in a cash flow problem?
Is it? "In the case of a taxpayer’s specified research or experimental expenditures for any taxable year—" is pretty clear. That means what someone wants to claim as research and experimental expenditures. "For the purposes of this section" also seems pretty clear. If you want to claim software development as R&E, it unambiguously qualifies. And now all R&E must be amortized.
I am not a tax expert, but it doesn't seem like there's any reason you have to claim software development as R&E.
This is my understanding as well. This whole issue seems rather… sensationalized.
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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 still don’t understand why it has to be RnD? If I made a million dollars and spent a million in salaries, I made no profit. The government shouldn’t be taxing me on no money made. They already get taxes on the salaries I’m giving out.
Because it was a way to get the budget "balanced". They declared R&D expenses to be different from operating expenses -- if you have the money to spend on R&D then you have money to spend funding the country.
It's never supposed to be about what's "fair" or what they "should" do. It's about the fact that they want to spend $X, and need to raise $X one way or the other.
In this case, though, it was purely a trick. They were required to balance the budget over the long term, so they spent money now and identified a pot of money they could take from later. They just kicked the can down the road, and now we've arrived where the can landed. They actually don't think it's fair, or reasonable, or productive. But changing it does make somebody responsible for a huge increase in the deficit... and it's the people who spent the money 5 years ago.
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That’s literally the point of this entire thread.
This change taxes you on profit you never made, and specifically targets software companies.
It’s insane.
It comes down to whether these salaries were a sheer cost and not partly an investment.
If you made a million dollar and bought a million in patents, you still would have no money but wouldn't expect to be paying 0 tax, would you ? How RnD should be taxed is up for debate, but at least the logic is that it's not a simple cost (in comparison to paying a janitor to clean the office for instance)
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Kinda like options - you get taxed on imaginary numbers on money you don't have access to. You received zero profits but owe taxes.
What would a welder do that isn't research or development? I believe for both jobs certain tasks are journeyman-like, but others are legit R&D. I don't think software ought to be blanket-exempted because its done on a computer.
Here's the IRS' guidance on software: https://www.irs.gov/businesses/audit-guidelines-on-the-appli...
> What would a welder do that isn't research or development?
Weld stuff?
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In "research and development", that typically means "research of new ideas and methods, and developing them into commercially viable products". So are there things that software engineers do that fall under R+D? Absolutely! Is adding a sorting feature to a grid in your app one of those things? Probably not!
You should never assume legal terms mean what they colloquially mean.
Just like how "work" in physics has a precise definition which doesn't mean what it colloquially means, or "tree" in computer science.
In this case, software development of any kind is explicitly included:
> 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
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> Is adding a sorting feature to a grid in your app one of those things?
Yeah, the love the tax write-off - they don't love paying people to actually research anything.
Maintain services. Why was everyone expecting Twitter to go down after the layoffs if software developers only do research and development of new products?
"I haven't yet gotten the answer for this each time this issue comes up."
Asnwer: It's not mandatory.
There are various tax breaks for R&D spending - so companies try and classify lots of things that aren't R&D as R&D.
There's been a bit of stink recently in the UK around R&D tax credits and how companies have been taking the tax man for a bit of a ride.
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.
What jurisdiction doesn't count employee salaries as an expense?
Salaries are already taxed as individual income. Taxing them as corporate profits and individual income is not closing a loophole, its double-taxing.
> 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.
This is not about tax credits, this is about whether salaries are an expense. If Widget Inc makes and sells a bunch of widgets for $100m, and then they pay $20m in rent, and $30m for materials, and $40m for salaries, with $10m left over, with no other complexities (eg, interest, depreciating factory equipment, etc.), then is their profit this year:
1) $10m (or maybe a bit less, if they got any tax credits)?
2) Some other larger number closer to $50m?
You'd be hard pressed to find many jurisdictionns where the answer isn't option 1. I certainly don't know any offhand.
It is not. If I pay a worker to frame up a house it is an expense. If I pay a swe to frame up a mobile app it is R&D. Again NOT a loophole.
> If I pay a worker to frame up a house it is an expense
If you are getting paid to build the house because you're in the business of building houses, then yes it is an expense. If you're building a house to keep ownership of and rent out, then no, that cost has to be capitalized and depreciated over the expected lifetime of the improvement.
The general question addressed by this law is "should it be allowed to reinvest profits tax-free and delay paying taxes indefinitely?". There are many places in the tax code where this answer is "no" (eg you pay taxes on bank interest yearly, even on a long term CD), and there are many places where this answer is "yes" (retirement accounts, US savings bonds, stock buybacks, 1031 exchange).
It's ridiculous that software development is getting singled out, given that for most business activity the answer is default yes, with only specific list of things that have to be capitalized. I'm just saying the right answer isn't set in stone, apart from of what the tech industry has gotten used to and how effectively abrupt this change was.
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?
Are you just framing up a mobile app for funzies?
Wouldn't it be a professional service, therefore an expense, therefore fully tax deductible?
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Maybe it was the point? Didn't you notice that the US gained certain lead in software technologies?
The developers, who are paid rather handsomely, also pay rather large amounts of taxes from their salaries. (If fired and jobless, they stop doing that.)
The Trump voters will be happy with the software developers all fired and jobless, because it brings them down to their level.
Well, salaries are expenses though. And software development is not necessarily R&D, so if 99% of software development has to be classified as such, that's a problem.
We are not talking about a tax credit here, but a deduction.
This is misinformation. You owe this tax even if you do not claim any R&D tax credit.
https://www.grantthornton.com/insights/articles/tax/2023/sec...
Uhhhhh… every single one up until this change.
100%