Comment by demosthanos

In my (admittedly lay) understanding of the issue, it boils down to software maintenance being taxed as research and development.

In general, costs for running a business (buying inventory) are immediately deductible, while establishing new business (building factories) has to be amortized, since the factory can be used for several years.

In software, the line is a bit more blurry - coding creates new IP (research), but is also required to keep many software companies running (maintenance) by e.g. fixing bugs and updating infrastructure. Here, the IRS has decided that all software development counts as research.

This would kinda make sense if you could hire programmers for a single year to develop software, fire them and then sell the software for 5 years, but I think that's rarely the case.

The comparison with Jim Beam is misplaced. Both TSMC and Jim Beam already have to amortize their production equipment over several years. I'm not arguing that this should be changed. This is because the primary risk taken in a distillery build-out or a fab build-out is if there is market demand for a known product. It's primarily a business risk, not a research risk. Tax code is a reasonable tool to regulate business risk.

The people this tax code change hurts are those doing basic research. In the context of semiconductors, that would be a company like ASML (except they are Dutch, so they can happily continue their research practices) who took a decades-long bet to build their EUV steppers.

In the case of basic research, one could be spending millions of dollars on hardware prototypes when you know it can't produce any salable product. There's no upside profit to amortize expenses against: it's like building a distillery that you know can't produce a single drop of salable bourbon because you're working out a radical new distillation technique.

In summary: in basic hardware research, one could be spending millions of dollars to put a whole system together just so you can learn how it fails. It's a true "expense", with no path to amortization.

Now, in addition to making the right technical decisions, the tax law changes force the R&D teams to also consider how to amortize their experiments over many years. You now have have pressure from management to do things like stage prototypes and expenses in the right tax year so the company can continue to show a profit for the shareholders. You could argue that the lessons learned are perhaps IP that have "goodwill" value, but now you're opening a can of worms trying to price a fair market value on a negative result, and you're now having senior research staff spend more time arguing with accountants than directing research. You also have to get to that negative result within a tax year - which effectively penalizes any research project that takes more than 12 months to complete.

Same-year 100% deduction of R&D expenses is simple and it reflects the actual nature of basic research risk. Yes, it allows companies to convert short-term windfalls into long-term research gains by converting taxable profits into research projects, but I'd argue that's not actually a bad social policy.

I think US is probably unique among developed nations in having a tax code that punishes basic research; other countries at least allow it to be deducted. Some even allow super-deductions (e.g. you can deduct $2 for every $1 of R&D expense) or the research is explicitly subsidized through grants.

The argument for special treatment of research is that pioneers put their careers on the line to discover new things, so the rest of us can live in risk-free comfort; so, as a collective we give them some reward for taking that risk.

I suppose the counter-argument is that research incentives and subsidies are socialist "market manipulation" and violate the "free market" principle, and thus America is justified in sanctioning and trade warring with the rest of the world that is socializing basic research costs. That's an opinion one is entitled to hold, but we'll have to agree to disagree on that opinion.

This is different because the value of the distillation facility is not defined as “the wages of the builders”.

It doesn’t matter. Jim Bean doesn’t compete with an R&D software company. The R&D software company does compete with other companies in different jurisdictions with better regulations.

I could see it being inferred that way but, the way I read it, they are not meant as unilateral facts. Rather, they serve as rhetorical examples of where you might find contractors doing similar work, but where the one more in service of "public good" is taxed higher because it's open source. Strictly speaking, Windows bits are not all closed source and there exist closed source Linux bits. But it's not a point that really matters in the context of the conversation.

I think it's fair to use Windows and Linux as stand-ins for closed vs open source because it's a very accessible example. And knowing the technicalities clearly doesn't undermine the argument.

You're right, the law text doesn't specifically call out the Windows operating system or the Linux operating system. The example you gave of Open Source Windows drivers is valid.

The Grandparent's point about that "it double-dings open source developers" is still correct and poignant even with this clarification.

You are correct. I picked this example under the general assumption that the Windows driver would be closed-source, but you are correct that it doesn't necessarily have to be closed source.

The problem goes with the license, not with the OS.

Work-for-hire open source contributions often already bear a copyright holder of the entity paying for the work. The problem isn't who is the copyright holder.

The problem is that the license assigned says that anyone is free to use the code. Anyone is a set of people that includes the contributor, which then triggers the interpretation that the research is incrementally in the contributor's benefit and thus disqualified from preferential tax treatment.

You'd need a custom license where everyone in the world could use the results except for the contributor, and then like, a source control system that hides the source files from the contributor's view of the repository.

Create a shell company with an X$ investment.

Have the shell company write code. (Or more risky pay your company to write code as a work for higher.)

Devolve the shell contributing its assets to OSS.

Take a X$ loss in that year.

Argue that it is perfectly legal to the IRS.

Eventually, as long as you survive that long.

As has been said repeatedly in this thread, this change is purely a boon for existing big tech companies that now have even less to worry about from startups. It takes a startup 5 years before they'll be playing on an even field with big tech.

> if you’re operating a profitable company

You keep saying this across this thread, and keep ignoring that Section 174 has now redefined "profitable" for tax purposes to include companies who:

* Are in year 1 with no history of expenses to draw on.

* Have spent <900% of their year 1 revenue on software development expenses.

i.e., a startup that earns $1mil and spent $8mil in software dev expenses is only able to deduct 10% * 8mil = $800k of expenses, which means that as far as the government is concerned they made a profit of $200k and owe taxes on that on top of their already-net-loss of $7mil.

You can keep ignoring this fact, but ignoring it doesn't help your case. If you want to argue that this is fine and dandy you need to explain why the above math doesn't prevent new companies from competing on fair terms with big tech.

Often the way this works is that some time bomb is added to the tax code so that forecasts for future tax revenue will be higher (justifying more spending in the short term) and congress then needs to remember to remove the time bomb before it blows up. So it isn’t that uncommon for these things to be reverted.

It's actually not uncommon for something stupid to make it to the official tax code and then get reverted. They knew the history.

Get a better government.

Foreign workers are to my knowledge effectively always a service contract, since it's pretty complicated (if even possible) to hire FTEs across borders without subsidiaries, which are expensive to maintain.

I'm curious if contract work is really exempt, would look like a major loophole to me.

This is simply not true. Says my lawyer and CPA. And every other CEO/CFO I've talked with.

Wait, salary costs do not count as costs for the year they're made in? That is completely nuts, no matter what kind of company you have.

Although for a startup it might be least bad, because for their first few years, their revenue might well be closer to zero; they tend to burn money, sometimes for quite a while.

Yeah, this provision is a complete fuck up.

This example only really has the emotional impact it does because of the specific numbers used, but doesn't really generalize for an arbitrary N.

Clearly if two software engineers build a product that brings in $10M, and each pay themselves $5M, it doesn't seem so outrageous that the can't really claim they're running "a business that made literally no money." Clearly in this second example the problem is that the engineers are paying themselves way too high given the return on their efforts.

What this means is that software engineers will be required to bring in more value to justify their high pay. In your example, it simply means that a software engineer that brings in $100,000 of value to the company, probably shouldn't be paid $100,000.

This seems entirely reasonable to me, and doubly so when I consider how many large corporate teams (who I think will ultimately be impacted more than startups) has huge numbers of highly paid engineers not doing all that much.

In most startups I've worked in it was pretty common for engineers to be delivering multiples of their cost in value, and in every big company I've worked in, it was very common to be delivering fractions of one's cost in value.

> Post Section 174, the profit is now $160,000 each year. Now they pay taxes on $160,000, even though they literally have no money left over because revenues equaled expenditures.

They have the $200k they pulled from their startup, far more than what most people earn. If you make enough to pay yourself $100k then you make enough to pay taxes.

> For unprofitable startups it could cause issues during a phase of very high revenue growth.

So I guess my most question is "how this work irl?"

Say a new startup raises money and hires 20 people. Pays $5m in salaries, office space and such. All 20 people are developing a software product. Are 100% of this startups expenses amorotized?

Then they sell the product. They receive $2m in revenue. What does the P&L look like.

It depends on the department. My salary (in a mature product) was already amortized - I suspect the same is true of all their other mature products like Search, Maps, GMail, Chrome, YouTube, etc. But I think they were deducting salaries in the more research-like areas like Gemini, Jax, Assistant, etc. So there is net still a fairly large charge related to it, even if it isn't as large as it could be.

No, you pay taxes on profits. What this does is reduce your upfront deduction.

> you don't pay taxes on profits, but on revenue.

That can't be right. It definitely isn't in my country.

If own a car dealership, and I sell a car for $50,000 that I bought from the manufacturer for $40,000, surely I would pay tax on the $10,000 profit? The tax on the the full $50,000 revenue might exceed my profit!

If companies paid tax on revenue the US budget would be perfectly fine.

I am so interested in what business you work in that you would think this could be true.

i think people in tech are usually focused on free cash flow, aka playing around money.

>Yes, that is tremendously important aspect here - the US tech would look better on paper

It's completely unimportant. Nobody is getting fooled "on paper" by amortized salaries.

> (15 for software engineers outside of the US)

Yikes. Does that apply to outsourcing?

> I think the purpose of the change was to "increase revenue"

Yes, but in a specific way: they were trying to offset the tax cuts they wanted so they could pass it via the reconciliation process and avoid the Senate filibuster. They didn't actually care about this revenue and the assumption from most people was that the specific carve-out would disappear in some future bill.

They want to call it anything other than a tax.

It's a specific tax, on a particular class of better educated workers in specific jobs.

Also, that administration was pissed off at tech.

I think partially dismissing the question due to the bill happening "under trump" doesn't help the conversation here. If the bill was sponsored by particular reps/senators, then it's worth identifying those, so their voters can factor this bill in to their decision to vote for/against in the future, etc.

If the list doesn't go on and on that is a clear sign that corruption is being hid.

> I thought you were being sarcastic here at first because,

You've never been in Russia. There is no clear law abiding business there. That opens a lot of opportunities for those with some power. Corruption is one of them, selective punishment is another. I'm sure in most 3d world situation is not better, but they at least don't have laws to cheat and bribing isn't a crime.

You have no idea about corruption if you haven't lived it in a BRIC country.

The funny thing, is that people not from America say that there IS corruption, but at least it happens in the open. I think OP is saying the same.

You forgot putting a dead guy on trial.

No, he's saying that people respect the law, which they do. It's all about finding loopholes, and sticking to the letter of the law while working around the law to do whatever the law prohibits but doing it in a way that remains legal. This entire situation came up because of loopholes. A great way to offshore money was to spend it on software developed by overseas subsidiaries.

If you’ve never lived outside the US you have zero idea how bad it gets. It literally is an alternate world.

The amount of daily activities in the US that just work 99.999999% of the time that would have a corruption aspect in some other countries is mind boggling.

The closest analogy I can come up with is imagine if every money transaction involved cash tipping the parties involved. And that’s just the beginning.

Or are cynical Americans living in an alternate world, blind to how much better the rule of law is here than most other countries? The commenter's comparison was to Russia. When was the last time Putin lost an election?

I'd say we're slightly behind western Europe as far as rule of law goes, not really sure about the advanced east (Japan, Korea), and miles ahead of just about everywhere else (eastern Europe, Russia, Africa, China, etc). Yes, even with Trump in office, though he really makes me worry.

How does this work, in your first year, to have 300K revenue on 270K development cost. It sounds like some very specific boot strapping case, and even then after 70K deductions its 230K profit, so like 50K in taxes on 30K profit. Sure it’s annoying, but it doesnt sound like total doom. Its more likely youll have 250K programmer expense in the first year, 100K in revenue, need 200K in outside investment, and pay very little taxes. After a couple of years it evens out anyway.

Consider some sort of logistics company. They might pay 250K for their hardware (e.g. vehicles), 50K in expenses, get 300K in revenue. Theyll be taxed the same as the startup building up their IT assets.

At least one person at every company impacted knows why they're firing people, right? Likely several people who are in a decision making capacity. At every company.

Those companies have R&D for a reason. A company _wants_ to make things, right? If this is impacting their ability to make things, wouldn't it be in a company's best interest to advocate openly against the tax code, rather than be silent about the reason, fire their staff, and just not make things?

It doesn't make sense to me how so many people are aware of this to the point that many many companies are all doing the same thing for the same reason, but seemingly nobody was talking about it before this post. That doesn't make a lot of sense to me.

Assuming this change is causing the layoffs, then these companies know about this.

If these companies don't know about this change, then why would we believe this change is causing it.

This is what I was thinking too

Startups have to face that five year window every time they start up.

Each and every startup will have a year 0 where they're spending more than they earn, and under the new Section 174 they will only get to deduct 10% of their employee's salaries that year. In year two they get to deduct 20% of year 1's salaries and 10% of year 2's salaries, which is still 30% of what the established players will be able to deduct. By year 4, if they make it that far (which most startups don't) they'll finally be at 90% of a full deduction.

Add to that the fact that startups also by definition have a much higher rate of growth than established companies and you'll find that a startup almost definitionally will be paying substantially more in taxes as long as it remains a startup, because they only get to deduct an average of the last 5 years of expenses from this year's revenue in order to calculate this year's profit. That's fine when your last five years are more or less similar to this one, but it's terrible when you've been growing.

The net effect of this change can only be to disincentive startups and cement big, slow established players.

That sounds exactly like what the parent comment said- a MAGA bill.

what do you mean by "sponsor"?

[dead]

It was indeed passed by Republicans in Congress (with Democrats mostly voting Nay), but it was signed by Obama (12/22/2017). Why did he sign it?

Until is is rolled back, it isn't rolled back.

too little too late?

as we are seeing now on a number of issues, sure things can be rolled back, but that doesn't mean a return to normal.

Yes, you can kick over a bee hive, then pick it up and set it back upright, but you are not going to put all the bees back in immediately. There are long term consequences.

The article is pretty clear that the law was from 2017 had a scheduled start date of 2022. Although probably not the actual intended effect, it does have the effect of confusing who would be responsible for it by those who don't read past the effective date.

The way this is "fixed" right now, every five years we need another round of republican government to make things great again. If only enough democrats cared to fix this.

Politics are complicated.

Generally, in tax bills they try to keep them "neutral" where any tax cuts or tax breaks are coupled with tax increases elsewhere BUT they tend to report the 10-year affect for whatever reason. This bill provided a ~30% cut in corporate tax on profits, with a delayed increase in tax cost on Software R&D pushed to the next term.

If the next party wants to reverse it, they'd have to find the money with an increase in tax - directly undoing it would be a ~50% increase in corporate tax rate, which (I guess?) would be a tough sell politically. Meanwhile, the tax code on software engineering sounds too niche to expend political capital on.

Either way, its another example of how corporate America is trading long-term growth (R&D, product development) for short term gain (lower taxes today).

They tried. They had Senate spoilers.

Why should they? Why did we allow a president to put in tax raise for the future. Replicants were playing politics from the start. Pass a bad bill, and then hope to get about it when the bad parts kick in when the other side woo be in power

if you retain power, you can fix it. the US government currently has the significant problem that one party campaigns on the government being dysfunctional, so they do their best to make it so.

No. It’s after re-election. Bad news late in your second term isn’t that big of a deal, unless you care about legacy.

No. It went into effect in 2022 [0], which means the timeline absolutely does track with OP's theory. That gives a hypothetical Trump term 2 a full year to fix it but also imposes enough of a time crunch that they could plan on sabotaging attempts to fix it by another party.

I'm not saying it's the actual story, but the timeline does track.

[0] Page 60, Sec 1306(e) sets the date: https://www.congress.gov/115/bills/hr1/BILLS-115hr1enr.pdf