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Ask HN: How are you handling Section 174 changes for bootstrapped companies?

298 points by silverlight 4y ago

Hey everyone, Was just starting the tax process for 2022 and found out about the changes that have been made to Section 174 that take effect this year. Essentially, all R&E expenses must now be amortized over 5 years (instead of taking them as a regular full deduction in the year in which they are incurred), and on top of that all "software development" is now an R&E expense. [1][2] This seems like a disaster for any bootstrapped software company. As an example, if you make $100k in income, and spend $90k making the software, at first glance you've got a successful company bringing in a 10% profit margin. Previously, you would have just paid tax on that $10k in profit. Makes sense. Under these new rules, the US actually says "that $90k you spent to make the software has to be spread over 5 years, and you can actually only take 10% of it in the first year." Suddenly you've gone from a profit of $10k to a "profit" of $91k for tax purposes. Even at a 30% tax rate (which isn't even close to the top rate in the US), you're staring down a $27k tax bill that you're somehow supposed to pay out of the $10k in actual cash you have left on hand. To be clear, you will eventually get the taxes you pay back over the next 5 years. But how are bootstrapped companies without access to large capital reserves or investment supposed to come up with the money to pay these tax bills while they wait it out? For every dollar you spend on making software, you've now got to have 30+ cents in reserve just to pay the tax bill for the year! I am completely flabbergasted as to how this was thought to be a good idea...it seems like it drastically increases the cost of starting a bootstrapped software company in the US, which is just terrible policy in general. Was just curious -- is this interpretation what others are hearing from their own tax professionals? Is it affecting others and if so how are you dealing with it? [1] https://rsmus.com/insights/services/business-tax/looming-required-capitalization-of-section-174-expenditures.html [2] https://www.taxnotes.com/research/federal/usc26/174

govert 4y ago
I am in the same position - my accountant got an opinion from a CPA who said that software development costs _must_ now be capitalized. My company sells support and maintenance contracts for some open-source software, and so the 'software development' entails updating the software to work on newer operating systems and platforms etc. Contractor programmers are paid to do this software maintenance work. At issue seems to be the interpretation of the change introduced in Section 174(3) saying: "(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." Does this mean that payments to programmers to fulfill the software maintenance contract _must_ be considered R&E expenditure (and can thus not be deducted as Section 162 "Trade or business expenses" and _must_ be capitalized in terms of the amendments to Section 174). If this is the correct interpretation of the amended law, I would expect large companies like Apple and Alphabet to be subject to this problem as well - surely it would be material if one of their main costs (being software developer salaries) cannot be expensed from this year. Yet I have seen no comments around this from that side, either explaining suddenly higher earnings or higher taxes due. If that is not the correct interpretation of Section 174(3), and some programming related costs are not to be considered R&E expenditure, how do I explain the reasoning to my accountant?
rco8786 4y ago
This does seem rather...terrible. I am assuming in this case you outsourced the software development and paid someone $90k out of pocket?
- eatonphil 4y ago
  Not an accountant so: Wouldn't taking a 90k salary be the same thing? (If you're building something new.)
  - rco8786 4y ago
    Yea I just figured a bootstrapper is not going to take a salary in year 1. But also seems like you could sidestep this by taking your salary as CEO rather than as a software developer or...something?
    - brianwawok 4y ago
      So I'm 6 years in as a bootstrapper. Let's say I took a 500k year salary and paid 1M to my developers. I always claim development as R&D. I now need to pay taxes on (500k + .8 * 1M = 1.3M?) Despite only taking 500K salary? At some point I would owe more in taxes than I took in salary..
      - silverlight 4y ago
        Assuming that your shop took in 1.5M in revenue, then yes it would be (500k + 0.9 * 1M) because for the first year you only get 1/10th of the deduction. So it's like: Year 1: 0.1 Year 2-5: 0.2 Year 6: 0.1
- silverlight 4y ago
  In the example I am giving it would be any expense related to "software development." So paying a salary to another person on your team (or 1099 income to a contractor), buying tools to aid in the development, anything at all really.
ilamont 4y ago
Wow. I had no idea this was happening. Not a peep from my accountant, either. I have an S-Corp so "profit" would pass through to my personal taxes. I've found over the years that most people writing and administering tax and business regulations at the local, state, and federal level have little clue about the needs of small businesses, whether it's a software startup or a local pizza place.
- silverlight 4y ago
  Correct, my company is a partnership LLC and these "phantom profits" are going to flow through to me personally to owe taxes on.
- edgyquant 4y ago
  [flagged]
- hesdeadjim 4y ago
  My expensive accountants didn’t bother mentioning the Section 174 changes because like every year since the 50’s that law has been delayed or overridden through other legislation. Manchin killed the bill last year that would have extended the protection from 174…
  - lotsofpulp 4y ago
    One politician cannot be held responsible for a bill not passing that requires the votes of many others.
    - adamsmith143 4y ago
      Are you aware of how the Senate has been operating for the past few years? A single Senator can indeed scuttle entire legislation.
      - bradlys 4y ago
        It’s all a horse and pony show. It’s most definitely not just one politician deciding things - they just want you to think that. Ever notice how the villain changes ever few months? It’s planned.
mritchie712 4y ago
Do you do your own taxes? Pilot is $500 a month, might be worth it if you're unsure how to handle this. I'm not associated with Pilot, just a big fan of outsourcing things like this. https://pilot.com/pricing https://pilot.com/pricing
phphphphp 4y ago
I am not a tax expert but my understanding is that a business would claim expenditure as R&D because of the beneficial tax treatment: it's a choice you make to categorise expenditure as R&D, you're under no obligation to do so. If the tax treatment of R&D spend has changed to be less favourable in your circumstance (i.e: you can't afford the short term cost of amortisation) then you would not claim the spend to be R&D related. After all, a small technology company working on their revenue-generating product is not doing anything experimental: it's only experimental if you massage it as such. I could be far off the mark -- so please correct me if I am wrong -- but your framing suggests that if a business spends money on software development then they must amortise the cost which does not seem to be correct.
- silverlight 4y ago
  This is how it worked in previous years. Previously, you could elect to take the R&E expenses either entirely in a single year or amortized over the longer period. This year the change is: 1) You can no longer take it all in the single year, and 2) All software development is now R&E automatically, no exceptions. Note that this is separate from the R&E tax credit that you can also claim, that's a different deal in addition to this.
  - TaxJD 4y ago
    I’m an attorney who works with companies doing software dev everyday, and this is not only a really bad tax policy, but will be detrimental to US innovation. There are a few things you can do, as many others pointed out, like claiming the R&D credit (section 41), extending your tax return, and making sure you have sources of financing if you a owe a big tax bill. My team also wrote an article on this subject a few weeks back with takeaways and graphs to show the potential math: https://capstantax.com/rev-proc-2023-11/ https://capstantax.com/rev-proc-2023-11/ If anyone wants to reach out to me, feel free to do so as my contact info is at the bottom of the above article.
  - jacobsimon 4y ago
    Reply from our CPA: “There's pretty widespread bipartisan distaste for that change and there have been multiple attempts to extend the deadline or amend the change, but they haven't picked up steam yet. Still possible it will be changed retroactively. The saving grace is that a lot of the expenses they are talking about you needing to amortize would qualify for the R&D credits you'll be getting. So there's often a substantial offset between the two.”
idlewords 4y ago
The answer is you spend part of the 10% profit on a CPA or tax lawyer. The legal deductions, they are so many. I've run a bootstrapped software business for 14 years and I never even heard of this one until your post.
- itake 4y ago
  How do you deduct payroll / dev costs?
  - idlewords 4y ago
    Me personally? The same way any small business does; I forget the exact line number but the upshot is you tell the IRS who you paid and subtract that amount from gross revenue.
    - itake 4y ago
      I think what OP is saying is that all software development costs must be amortized now. Most small businesses are not developing their own software and would not be impacted.
      - idlewords 4y ago
        What I am saying is that this is a bad topic to take message board advice on.
    - PaulDavisThe1st 4y ago
      > you tell the IRS who you paid unless they are overseas and have no US tax liabilities.
- moneywoes 4y ago
  Is there a list of these deductions somewhere for those who can’t afford a cpa or tax lawyer
  - 4y ago
MissTake 4y ago
Granted I may be reading this wrong (dog knows I’m confused over the US tax code at the best of times), but I got the impression from reading this link (https://www.plantemoran.com/explore-our-thinking/insight/2022/12/section-174-research-expense-rule-changes-excluded-from-final-bill-of-2022 https://www.plantemoran.com/explore-our-thinking/insight/202...) that the 5 year rule wasn’t yet in place.
- silverlight 4y ago
  What that article is saying is that there was hope that they would act and do something so these rules didn't take effect. Congress did not act and so these rules are now in effect. These rules were established as part of the 2017 tax bill and take effect this year. FTA: "The short answer is that the conclusion of the current congressional session with no action on this issue means required capitalization of R&E expenditures remains applicable to the 2022 tax year."
benmanns 4y ago
Yuck, it seems like no exceptions, minimums, or safe harbors that I can find. Definitely something to keep in mind and save/price accordingly. Seems like bootstrapped software needs to charge 30-50% more than 2021 and prior, at least for the first 5 years.
usefulperstive1 4y ago
> ...and spend $90k making the software Well, did you spend the $90k on W2 salaried employees, or to a vendor? > Essentially, all R&E expenses... The R&D tax credit was too good to be true anyway. The crazy loopholes are crazy. What were people expecting? Congress was not going to let people outsource "R&D", which in the bulk of cases is large companies like Accenture and small companies like bullshit agencies doing straight-up software customization that had little to do with real research or development. Insofar as it affects startups, the amended law seems to exist explicitly to rein in the pro-forma declarations / reports template-generated by non-specialists. Every tax or HR related firm in existence has been hawking this bullshit to tech companies for a while. Truly a bunch of parasites. Congress needs to repeal the R&D tax credit as it exists today and allow people to ordinarily expense whatever it is that they are doing. If it feels there is a good reason to make the money-to-US-salaries tax-reduced, it should make a simple blanket declaration checkbox for a narrow set of qualifications that would obviate the need of "R&D tax credit specialists."
- silverlight 4y ago
  This is not the same as the tax credit. That is a different deal. Even if you do not claim the credit at all, you still have to do this amortization. > Well, did you spend the $90k on W2 salaried employees, or to a vendor? It wouldn't matter, if the expense is related to the business of developing software, it counts now.
  - a5seo 4y ago
    As a solo developer, I guess I’m going to start tracking how fast I type and the size of my code commits each day, and that, my dear IRS friend, is the only part of my day I spent “developing software.” The reality is that even if you hire a “software developer,” they aren’t going to spend 100% on it. So now you have a situation where the IRS is supposed to audit how? Watch how much support you did? How much training and coaching other developers? How much email/scheduling/admin bs? Was that meeting about software development or customer research? The fools who write these laws are just ridiculously out of touch.
alexb_ 4y ago
>I am completely flabbergasted as to how this was thought to be a good idea...it seems like it drastically increases the cost of starting a bootstrapped software company in the US, which is just terrible policy in general. Oh it's a terrible policy for you. Yes, for you, the person who may want to actually create something which threatens the people who own large businesses, this is quite terrible. But for the people with lobbyists who want to make sure competition is made almost impossible to happen, it's just amazing.
linuxftw 4y ago
There's an R&D tax credit. See [1]. I would aggressively pursue this option. Much better than a deduction anyway. 1: https://www.hklaw.com/en/insights/publications/2023/01/rd-considerations-in-the-time-of-nondeductibility https://www.hklaw.com/en/insights/publications/2023/01/rd-co...
- codazoda 4y ago
  Specifically, that law firm says... > Startups unable to utilize the credit under Section 41 should consider whether an amortizable expense under Section 174 or an immediate deduction under Section 162 is more appropriate. So, their interpretation seems to be that you have three options.
  - linuxftw 4y ago
    Right. And 'unable to utilize' I think just is about the credit being non-refundable. EG, if are otherwise already showing a loss, then you don't want to use the credit. If you have reportable income, then the R&D credit might be beneficial. Though, I'm not sure you can split the credit or carry any forward, etc. Every tax situation is different.
- nodamage 4y ago
  Under the previous law it was not a mutually exclusive choice, you could deduct the R&E expense under Section 174 and also claim the R&D credit under Section 41. Under the current law you can no longer do both, if you want to take the R&D credit you have to instead amortize the R&E expense under Section 174. Or from the other comments in this thread it sounds like you can maybe skip the R&D credit and then continue to deduct the R&E expense under Section 162. But it's not clear (to me anyway) whether Section 174 supercedes Section 162 in the case of software development costs, in which case you might no longer be allowed to apply Section 162.
  - linuxftw 4y ago
    I was reading elsewhere that it doesn't supersede, rather S 162 can't be used by 'startups.' Startup meaning the business hasn't actually started selling anything. So if you're generating sales related to the software, then S 162 applies.
bryanlarsen 4y ago
> But how are bootstrapped companies without access to large capital reserves or investment supposed to come up with the money to pay these tax bills while they wait it out? You can go to the bank and take out a loan. It's called a "factor loan", and tax receivables are solid collateral.
- silverlight 4y ago
  That may be one option, but now I'm paying interest to give the government an interest-free loan in an inflationary environment. Great.
  - bryanlarsen 4y ago
    Oh, it's worse. You also have to have your books in good enough shape for the bank, and submit them regularly. It's like doing taxes twice. Having your books in good shape is a good idea for many other reasons, but it's one more thing. Better than bankruptcy, though, and it's often better than accepting VC terms.
deleted 4y ago
[deleted]
jollyllama 4y ago
IANAL but maybe marketing took up way more of your time this year
- silverlight 4y ago
  Yes I assume the definition of "software development" is going to be stretched as far as possible by most companies this year.
  - jollyllama 4y ago
    Does customer support fall under a different category? That takes up a lot of time too.
    - silverlight 4y ago
      Yes absolutely. I put forth a very simplified example to illustrate the point, but I assume any competent CPA (of which I am not so this is not actual advice) is going to tell you to try and separate out as much as possible that you can reasonably claim isn't "actual software development". I'm more just frustrated at the need to do any of it, as the underlying principle is so anti-small-business. Why are we making anyone in the software field jump through all these extra hoops now just to keep their company viable?
      - rglover 4y ago
        Because big corporations can be easily controlled by a hostile government while small businesses (absent legislation and other covert means like this) are not as easy to control. Simple as.
        jollyllama 4y ago
        Agree w/ GP that it's dumb. And you may well be right, it does feel malicious.
hesdeadjim 4y ago
It’s an absolutely fucked situation. In what world is revenue taxed *before* expenses. It’s a nuclear bomb for US innovation. Meanwhile China offers a 2x credit and the EU is almost as generous. Our accountants have been apologizing for a month now about the lack of heads up because they were confident congress would extend it like they always have. Nope.
- MNCPAGuy 4y ago
  Revenue taxed before expenses? That’s not what is happening or a good way of explaining it . It’s a temporary timing difference for recognizing expenses and deducting them on the tax return.
- dcow 4y ago
  That’s not how it works. OP is misinformed.
  - CamperBob2 4y ago
    You said elsewhere that you're not an accountant. What are your qualifications?
    - dcow 4y ago
      Just another misinformed internet commenter. You are free to draw your own conclusions.
  - dheera 4y ago
    That also is an issue. US tax law is so damn complicated people spend time on understanding taxes instead of science.
    - freedomben 4y ago
      Even the people who professionally do taxes (Accountants) can barely understand it and are debating it. It's utter insanity
  - 4y ago
leetrout 4y ago
It also says in Sec. 1.174-3 Treatment as expenses: > Research or experimental expenditures paid or incurred by a taxpayer during the taxable year in connection with his trade or business are deductible as expenses, and are not chargeable to capital account, if the taxpayer adopts the method provided in section 174(a) Seems like there could be room to challenge "all software dev is R&D"
dcow 4y ago
Why is everyone so confused? You only pay taxes on profit. Period. That hasn't changed and probably never will. If you do “R&D” you can elect to receive a credit. This credit which used to come all in one year, now must be amortized over 5. If you don’t want that to happen or cant afford it, don’t take the credit. It’s that simple. Not all software development is automatically forced to be R&D. That’s absurd. IANAA just a poor misinformed internet soul and this is not tax advice.
- silverlight 4y ago
  I agree that you are making logical sense. I think you should review what I linked or talk to a CPA because this this indeed the change this year, and it is indeed nonsensical. This is not the same thing as the R&D tax credit.
  - dcow 4y ago
    From TFA > Generally, section 174 expenditures escape the application of being classified as “start-up costs” under section 195, which generally requires expenditures that qualify as an expenditure under section 162 to be capitalized and recovered over 15 years once the taxpayer begins their business. Startup costs are things paid to start the business. Once the business is up and running you are “carrying-on” even if you’re not making money. It’s unfortunate that we use the word startup colloquially to mean non-profitable company, because thats not what it means in the IRC.
- overrun11 4y ago
  > You only pay taxes on profit. That's the question isn't it? What is considered your profit depends on what costs you must amortize vs. expense in year one. I'm not super familiar with this legislation but the concern is that it shifts development costs that were previously expensed to now be amortized.
- nodamage 4y ago
  You appear to be conflating R&E expenses (Section 174) with the R&D credit (Section 41). Everyone knows taking the R&D credit (Section 41) is optional, that's not what is being discussed here. The actual question is: if you have incurred software development expenses (e.g. wages paid to software developers), are you required to treat them as R&E expenses under Section 174, or can you instead treat them as ordinary expenses under Section 162?
ravagat 4y ago
Wow, I missed this, thanks for sharing. I didn't even hear anything from my accountant
rubyist5eva 4y ago
classic regulatory capture, thanks Trump!
johnrob 4y ago
Could you request a multi-year payment plan for the 2022 tax owed balance?
nodesocket 4y ago
First I’m even hearing about section 174. I just pinged my managed accounting and tax service. Shameless plug, but if you have a small business and looking for somebody to manage S corp, payroll, accounting, taxes, I highly recommend http://collective.com http://collective.com. I just integrated with them for 2023. Use my promo code if you want, gives us both discounts. https://share.collective.com/JK2020 https://share.collective.com/JK2020
- silverlight 4y ago
  Let us know what they say!
- arikr 4y ago
  Slightly odd to plug them given they didn't seem to be on top of this issue
voakbasda 4y ago
Gosh, doesn't this just reek of a move to entrench established big business by erecting regulatory hurdles, designed primarily to prevent anyone from following their path to success. That may not be a charitable take, but the politicians and corporations no longer deserve an ounce of beneficial doubt when it comes to the games they play.
brentm 4y ago
According to Journal Of Accountancy[0] this seems to only apply to software expenses that are also treated as R&D expenses. So if you expense the costs and don't claim R&D credit you lose the credit but would also not have the cash flow issue being described. It's still a net negative but at least less negative for current year cash flow. [0] https://www.journalofaccountancy.com/issues/2022/nov/amortizing-r-e-expenditures-under-tcja.html https://www.journalofaccountancy.com/issues/2022/nov/amortiz...
- silverlight 4y ago
  I don't really see anywhere in that article where it says that you can have software development expenses that aren't R&E expenses under the new definition. Am I missing it or? In fact it says: > The TCJA added a special rule under Sec. 174(c)(3) for the treatment for software development costs, stating that “any amount paid or incurred in connection with the development of any software shall be treated as a research or experimental expenditure.” Prior to this addition, taxpayers relied on Rev. Proc. 2000-50, which stated that the costs of developing computer software so closely resemble Sec. 174 R&E expenditures that a similar accounting treatment should be used. When this revenue procedure was issued, R&E expenditures were currently deducted. Under the TCJA, software development costs are treated as R&E expenses but are now subject to five- or 15-year amortization. ...which is what I am saying in my example -- software dev costs are now forced to be 5-year amortized.
  - brentm 4y ago
    You could be right. I was relying on some the other less formal language like: > companies engaged in research and development (R&D) activities should be implementing this significant change I think it might require backing up into tax code Sec 174 "Amortization of research and experimental expenditures"[0] itself though. There it says: > (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. Keying in on "For purposes of this section" I think we'd need to figure out is software development expense always required to be treated under this section, or is this just talking about software development expenses that are made in connection with R&D expenses which are under this section. It's hard to imagine all and any software development expenses are R&D. E.g. if you're running a software service company and have 10 engineers building something for a client, maybe it's R&D for the client but it's in not at all R&D for the service provider....right? I am not a lawyer or tax accountant so I may be way off base here. [0]https://www.law.cornell.edu/uscode/text/26/174 https://www.law.cornell.edu/uscode/text/26/174
jedberg 4y ago
I have a tax pro for this very reason, but my understanding is that you have a choice on how you want the tax treatment -- you can deduct it now as a business expense or over five years as R&D, which gives you a better tax deduction in the long run but fewer up front benefits. But at the end of the day I pay the tax guy to worry about it for me.
- silverlight 4y ago
  Did you talk to them about this specific change recently? Because how you're describing it is how it used to work, just not starting this year. Also thanks for Reddit ;)
  - jedberg 4y ago
    I admittedly have not talked about this with them. I assume he would tell me if it ends up making a difference, but maybe he'll just surprise me in April!
- w4 4y ago
  You don't have a choice anymore. It's required to be amortized as of FY22. I had the same conversation with my CPA in January. To make matters worse, failed or abandoned R&D projects can also no longer be written off, and must also be amortized even though they resulted in no new products or innovations. All of these changes greatly increase the risk of new R&D projects. It's an absolute disaster for innovation in a time when the US is ostensibly entering into a great-powers competition with China.
ilikeatari 4y ago
Yes, it's a big issue. It's fascinating how little it's talked about. I think this requires that we organize grassroots visibility into this. Also, wouldn't YC have some mechanisms to organize? I mean, I think this impacts every tech business other than unicorns.
- silverlight 4y ago
  I have also been surprised since I found out at the lack of discussion. Based on this post, it seems like many people didn't know. I assume a lot more are going to find out as we get closer to actually filing taxes. What I've heard is that there's already strong support for changing this but it's just a matter of Congress actually being functional, which political affiliation aside, it's not right now.
  - karmelapple 4y ago
    This is also the first I've seen this discussed in a tech setting. I'm glad it made it to the HN front page, but I'd like the desired change to make it into a bill to be passed by Congress before we all pay our 2022 taxes on April 15. What groups out there are fighting this?
vmc_7645 4y ago
Can someone explain in more basic terms what is happening? I'm not the most experienced in this area.
pclmulqdq 4y ago
I am not a tax expert at all, but I pay some tax experts a lot of money, because I do a lot of bootstrapped R&D and the tax laws around it are nuts. My accountant has suggested that I am totally fine, but my lawyer told me he wanted to do more research (not that this was an outright bad rule), but didn't think I would be stuck on this. I declined on the research (legal research is very expensive). My lawyer is very conservative, and my accountant is very liberal on this sort of thing, so that's the range of opinions I'm looking at. In general, I'm not so sure this is particularly apocalyptic unless you are bootstrapping with high expenses, and you are doing hard tech without a launched product. If you have a launched product, software development can be an operating expense. If you don't, it's harder to justify. If what you are doing has low technical risk, you can also put the number in a different spot on your income/loss statement and operationalize it. If what you are doing has low expenses, it probably doesn't matter much either way because it's not worth anyone's time to figure out if you can actually claim the credit. If you are bootstrapping a hard tech product and have not launched anything yet, I hope you can afford the amoritzation, because you might not be able to afford your technical risk either.
- bombcar 4y ago
  As a general reminder as long as you have a reasonable interpretation of the tax code; even if it is NOT the IRS's (and the judge eventually rules for the IRS), you will likely be clear of penalties. If you try to avoid ever getting entangled with the IRS you will way overpay. E.g,: https://johntreed.com/products/aggressive-tax-avoidance-for-real-estate-investor https://johntreed.com/products/aggressive-tax-avoidance-for-...
  - notshift 4y ago
    Would you recommend that book or any others on real estate / real estate taxes? I'm thinking about getting into the market soon.
    - bombcar 4y ago
      Anything by John is highly recommended, but he's honest about the whole thing, and small rentals aren't necessarily the greatest.
worik 4y ago
I have been reading the comments, I cannot help. But it is a powerful argument for simple tax codes. I like the idea of tax. I'm happy to pay my share. I am in unhappy about all the leeching lawyers I expect in your country as in mine, rules are made by lawyers and mainly benefit them
jjk166 4y ago
Sounds like you paid $9k for software development and $81k for other computer services.
remote_phone 4y ago
You’re using the term “R&E”. What does the E stand for? I’ve only heard the term R&D.
- silverlight 4y ago
  Research and Experimental. It’s what the tax code calls it. https://www.taxnotes.com/research/federal/usc26/174 https://www.taxnotes.com/research/federal/usc26/174
- pacificmint 4y ago
  Research and Experimentation
armatav 4y ago
Need you guys in larger, hard tech focused companies for impending strife.
Klonoar 4y ago
How does this apply to individual software dev consultants/contractors who operate under an LLC? (Obligatory "should ask a CPA" but I don't see much mention of this case around anywhere)
- sprite 4y ago
  Wondering the same thing.
- w4 4y ago
  Ask your CPA. Not a CPA and this isn't tax advice, but based on what I understand about the change you'll probably not be impacted if you're contracting for clients and not creating the software for yourself. Your clients will be impacted by the amortization issue when it comes to deducting your consulting fees. I asked your question in reverse ("How would this change impact hiring contract developers?") and was told that was probably how it would work. But again, I am not a CPA and this isn't tax advice, so you should really ask a CPA. A CPA might not even be totally sure about how it works yet, as there seems to be a lot of confusion about the rule change. Your client agreements may also have an impact on the answer (for example, does the client own the IP or do they license it from you?). So you really need to talk to a CPA! Tax concerns aside, downstream effects may be an issue for you: If my understanding is correct, clients will no longer be able to immediately expense your fees, and will be required to amortize them over five years. I would expect that this will therefore likely result in less demand for software contracting services in the overall economy as businesses become aware of the change and reevaluate their build vs. buy decisions.
givemeethekeys 4y ago
What are some examples of R&D expenses that couldn't easily be categorized as regular expenses? If I run a software business that brings in 100k but spends 90k on developers, then thats money going for salaries or contracting, both of which are fully deductible.
- w4 4y ago
  I am not a CPA, but my understanding from extensive discussions with one is: If the salaries contributed towards the development of new software it is an R&D expense. You must amortize them. Those salaries or contractor fees are not deductible. Maintenance of existing software might be treated differently, and may or may not be deductible. But it's very unclear. For example, is adding a new feature to existing software R&D that must be amortized, or is it maintaining an existing asset and thus deductible? No one seems to know, and the IRS hasn't responded to requests for clarification from the CPA associations. This is new as of the 2022 tax year, thus the considerable confusion.
  - givemeethekeys 4y 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/#Evaluation https://taxfoundation.org/research-and-development-tax/#Eval...
splitstud 4y ago
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mikestaszel 4y ago
Could this be a factor in tech industry layoffs?
w4 4y ago
Everyone commenting in this thread that R&D can be written off is working with outdated information and is not up to date with the current state of play. I had the exact same conversation with my CPA last month. They told me the same things that you were told by your CPA: R&D expenses, including software development, must always be amortized over 5 years starting in FY22. The R&D tax credit has nothing to do with it. There is no option to deduct these expenses. Amortization also now applies to failed or abandoned R&D projects, which is a major change that seems likely to be devastating to innovation. In my opinion this rule is a disaster. Call your congressperson and your senators: https://www.congress.gov/members/find-your-member https://www.congress.gov/members/find-your-member
- MNCPAGuy 4y ago
  Great info and comment. Thanks!
- silverlight 4y ago
  I did contact my Congressional Representative but I would love to know what interest groups are working on this actively that I can support further. Thank you for sharing your own experience with your CPA as well.
  - w4 4y ago
    > I would love to know what interest groups are working on this actively that I can support further Same. If you learn of any please drop a comment, and I will do the same!
- phphphphp 4y ago
  The point being made by myself and others in this thread doesn’t contradict yours: all software development is not R&D, R&D is a specific activity related to speculative work. A bunch of people churning out code to support a revenue generating product are not engaged in R&D. Historically, it has been beneficial to classify as much as possible as R&D because of credits. The point of contention is not whether R&D must be amortized, it’s whether or not R&D classification is a choice. Some in this thread have argued that the rule change means that all software development is now R&D which would be a radical change and would have the impact that the OP describes. I’m still not convinced by the argument that all software development is now R&D: it just doesn’t seem plausible, what on earth would be the reasoning behind that? Yes, this bill is garbage and it may have unintended consequences, but to suggest they’ve accidentally made all software development be R&D seems inconceivable — even before considering the amortisation consequence.
macinjosh 4y ago
Gotta love democracy, see where all your voting had gotten us?

Majromax 4y ago

> In what world is revenue taxed before expenses. All of them, for capital expenditures. If I buy a widget-maker for $100,000 and use it to make a profit of $50k/yr on widget sales (net of staff and materials), then I don't have a $50k loss in my first year and $50k in profits thereafter. Instead, the cost of the machinery must be amortized (depreciated) over several years, with a five-year period being typical but not universal. In the latter case, even though I had a $100k cash outlay for the machinery, I'd still record a tax-time profit of $30k for the year ($50k operational net revenue less $100k/5 years). Is software an operational or a capital expense? There are arguments for each approach, and reasonable governments might decide the issue differently.

silverlight 4y ago
I think the main difference is: 1) You can't just go get a loan for "a software" like you can "a widget maker." Most businesses with these large capital assets get loans on them and then it works out nicely as you pay back the loan on the asset while you depreciate it. 2) This would be like the law saying "anything you do in the business of making widgets at all is now a capital outlay" which is obviously ridiculous. It's not that they said "if you buy expensive tools to make software now you have to capitalize them", it's written that any expense at all in service to software development is something now capitalized. Not that you agree with what's been done and I appreciate your example, but I think it does give a good contrast to see the differences.
Firmwarrior 4y ago
Man, this sounds pretty apocalyptic to me, but maybe I'm misunderstanding it entirely Let's say someone bootstraps a company under the current laws. They deposit $200k into a corporate bank account. In 2023 they pay themselves $50k and make no revenue. In 2024 they pull in $60k in revenue and pay themselves $50k again. For tax purposes, they'd have $60k - ($10k from year 1) - ($10k from year 2) = $40k in profit to pay corporate taxes on?
- silverlight 4y ago
  I don’t actually know how it works for paying yourself. But if you were paying someone else, in 2024 they would get 10k carried over from 2023 and $5k from 2024. You only get 10% the first year. I am not an accountant and this is not tax advice :-)
- cft 4y ago
  If you are paying only yourself you are probably a disregarded entity for tax purposes and you don't get to write off your salary anyway (before 2022 or after). In theory you could treat your one man startup as a C corp, but that would make very little tax sense, regardless of these changes. Also if it's your own 200k, you don't pay tax on it because you've put it in the bank and then taking it back, even in a C corp: you pay tax on the revenue from others. The problem seems to arise for purely bootstrapped companies with contractors that have no startup capital. This is quite rare i think, because you'd probably start incurring expenses for a couple of years before you earn any revenue, expenses that you can then amortize once the revenue appears. If you are a small company but not a startup, then your software expenses are probably not R&E, they are ordinary section 162 expenses. It's a law in the opposite direction nevertheless impeding innovation (i wonder the intent!), because it adds complexity for the tiny poorly funded businesses
  - Firmwarrior 4y ago
    Thanks dude. This is a good reminder that I need to talk to an accountant before I start messing around with tax-incurring stuff

silverlight 4y ago

So you're saying that the advice you got was that if it's a launched product, you can treat software development as an operating expense and just ignore the fact that 174 says software development is an R&E expense? I mean that sounds great to me...I just also feel like it's probably a very "liberal" interpretation indeed. The part I'm getting hung up on is essentially, previously R&E expenses (as you note) were a lot more fungible, it depended on a number of factors including how risky the endeavor was. Things that you just do day-to-day in the service of keeping your company afloat (which for a launched SaaS for example would include fixing bugs or even developing basic features) were likely not R&E. Maybe if you embarked on a journey to develop a totally new product, it would have been. It seems like the most basic reading of this is pretty straightforward: they've taken that decision making away and said "if it's software dev, it's R&E." Not "if it's software dev for a new feature, but hey existing bug fixes and maintenance don't count," just, "software is R&E now always." Obviously everyone has their own risk tolerance for how they interpret things and what definition they use.

pclmulqdq 4y ago
The key is that as long as your interpretation is reasonable, you won't be penalized, and as long as the numbers are fine, you probably won't even be audited. If you have a good representative, you may even be able to convince an auditor that your interpretation is correct. And yes, I would say that software that isn't continually developed rots, so if you have a launched product, you aren't really working out your technical risks, you're keeping your revenue stream alive. That sounds like a cost of goods sold to me. Previously, all of our accountants wanted our work to be R&D, which is why we include things like "all software development" in R&D. Now, we may not want it. There are a lot of other places you can put it. EDIT: CRUD apps have always been on the line between R&D and not R&D, so let's just put our toes on the other side for 2022 and beyond. In comparison, biotech and hard tech endeavors are screwed because that's not even arguable.

w4 4y ago
I think that is broadly right in theory, yes, though the IRS isn’t saying that currently. They haven’t provided any guidance at all last I heard, in spite of being asked for it by industry groups many months ago. Setting aside the apparently absurd state of things as they stand today, I agree in principle that coding that doesn’t result in a new asset shouldn’t be treated as R&D and thus should be deductible even under this regime. However, the issue that we’ve been grappling with is that even if we end up there, it’s still not totally clear where the line is with regards to software, as software is markedly different from other asset classes (e.g. machinery or equipment). Code written to support an existing revenue generating piece of software may still be R&D. For example, is adding a new feature to software R&D that creates a new asset (the new feature and new software version), or is it maintenance of an existing asset (the existing software)? It’s a mess. Under the previous regime this wasn’t an issue; you had an option to treat software development either way, so no one was worried about these nuances because it was a choice, meaning there was no way to get it wrong. Not so anymore, and the IRS is not helping to understand it right now based on what I’ve been told. Then add in the administrative burden presented by this change: Software devs are likely to get very familiar with 0.1 time tracking that lawyers and other professionals suffer with if this change sticks, so that businesses can figure out what is deductible and what must be amortized. Another issue is that if you dispose of or retire the asset there doesn’t seem to be any provision to accelerate or write off the depreciation immediately. This starts to look like a particularly pernicious challenge in the case of startups, for whom cash flow is an issue and who may very well fail before the 5 year amortization period is up. It’s also a major potential issue in the case of re-writes. The apparent inability to write off failed R&D is also a devastating change in my opinion, and its impacts extend well beyond software. It greatly increases the risk of R&D at a time when we need it most to confront challenges like climate change, to remain competitive with China, to capitalize on opportunities in AI, and so forth. So while I agree with you in principle, even if that’s where we end up - and it makes sense that it’s a reasonable outcome if deductibility is not restored - it’s still a real mess compared to where we were previously, and will have the effect of stifling innovation and economic growth. EDIT: Cleaned up a bit. A lot of folks do contradict my point: They’re saying that you can still deduct software development R&D citing old info, or that you can deduct it if you don’t take the credit. That’s just wrong.

CH1jZci6jV 4y ago

I am a formal congressional staffer in both the House and the Senate and virtually no one reads any given bill or even cares much about what is in it other than memorizing the talking points about it. Bills are almost completely written by lobbyists and a bunch of 23 year old staffers are not knowledgeable enough to have any valid comprehension or input. The job of a congressional staffer is to ensure reelection so we spend almost our time getting the member on the most powerful committees (for more campaign contributions) and getting on tv (for free media). Committees do spend more time on the content of bills but each member usually only has one staffer for multiple committees and they are still told how to vote by the party.

ccleve 4y ago
This is true. I was a congressional staffer long ago, and before that I was an intern at the Legislative Digest, an official publication that summarizes legislation for the members of Congress. These summaries were often the only thing that members would read before they voted. If a member was really ambitious, he or she might read the committee report as well. But that's it. I wasn't 23 years old when I was writing these summaries. I was 21. There was no one in the office over 30, and no lawyers. https://en.wikipedia.org/wiki/Legislative_Digest https://en.wikipedia.org/wiki/Legislative_Digest
rkagerer 4y ago
This is one reason why I think there should be a cap on the total volume of legislation (measured in pages). If you want to pass a new law, you need to repeal an old, obsolete one. Nobody should be subject to a corpus of rules too volumous for them to read and understand. It's absolutely unforgivable that legislators don't even read the laws they pass.
- thaumasiotes 4y ago
  A version of this system was apparently implemented in Iceland - under the traditional law, once a year a designated person had to recite the entire law, and whatever he forgot to include was no longer the law.
snowwrestler 4y ago
There are 435 House members and 100 Senators. On any given bill they are not all going to have a role in shaping and negotiating it, and their staff will not have access to bill language as that is happening. Or perhaps even right up to the vote. That does not imply that no one reads any bills. As a change to the tax code, the Section 174 language we’re all talking about was read by at minimum the (very capable) professional staff of the Joint Committee on Taxation and the CBO, for purposes of scoring the revenue impact of the bill. The impacts of the Section 174 changes are in fact intentional, done to change said scoring. Whether or not they would be popular was not the point; all changes to the tax code are unpopular to someone. The point was to find a configuration of changes that could pass both houses at that time and get signed. That usually means a few big-ticket changes, and then lots of monkeying around with other things (like R&D) to offset those.

HillRat 4y ago

The 2017 TCJA was passed on pure party line votes (in the House, all Democrats and 12 Republicans opposed the bill), so it definitely wasn't bipartisan. More generally, big tax cut (the top 0.1% saw about $250K in lower taxes under the TCJA) and big spending bills jam in all sorts of random shenanigans to try and prove themselves revenue neutral, even though they almost never work out as described. One favored tactic, as we see here, is to kick big cans down the road and let a future Congress work out the problems. They (and this is one of those cases where both parties are equally complicit) know what they're doing, they just don't want to be honest about the fiscal implications of what they're doing. Fixing these tax issues, on the other hand, would have had to be attached to the NDAA or omni last session, both of which require bipartisan support; big bipartisan bills are so contentious that it's hard to get unrelated deals through, especially since everything goes down to the wire these days. In this case, a deal that would have expanded child tax credits in exchange for a bunch of corporate and high net-worth household goodies, including section 174 fixes, was on the table, but couldn't get through negotiations. (I'll note that, while the Republicans created the section 174 mess in the first place, they are now trying to repeal that and other TCJA changes, but aren't willing to add lower-income individual tax cuts into the mix, which is what stalled things in the last Congress.) It's a hell of a mess, and things are made crazier by the weird power dynamics in the current House leadership, where a small group of fiscal bomb-throwers have outsized power in the Republican party (and it's not clear that they care about tax minutiae, at least not while they're playing with a federal default on the national debt), but the inter-party margins are so slim that you could potentially cobble together a bipartisan majority on the edges. No one seems to like the section 174 situation, so it's at least theoretically possible that you could get a small coalition together to cut a deal at the last minute -- but I'm not sure we can count on that.

silverlight 4y ago
Wow, thank you for that detailed explanation. Very interesting.