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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

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"?

cdot2 4y ago
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?
- sangnoir 4y ago
  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-application-of-the-process-of-experimentation-for-all-software https://www.irs.gov/businesses/audit-guidelines-on-the-appli...
  - TylerE 4y ago
    > What would a welder do that isn't research or development? Weld stuff?
    - jdmichal 4y ago
      Isn't welding just "developing" metal products? That's why you have to take into account that it's "research and development", and not "research" and "development". As in research and the development of that research, not separately research and development.
      - function_seven 4y ago
        Yeah, forcing physical-world norms into technology will always result in weird shit like this. For the "real" world, Research would be studying different compounds to see which ones work well as anode or cathode. Development would be creating the industrial processes required to scale up manufacturing, or the ancillary infrastructure to support the new battery, or designing a new package for this awesome new cell. All the things that take the new thing from the lab to a marketable product. So if you come up with a new method for welding ("My new filler alloy reduces argon requirements by half!" or "My new pulsing methodology results in 23% stronger welds between dissimilar alloys.") That's Research. Then the Development of that might be "How do we manufacture these new filler rods to the exacting specs required?" or "We need to have the EE people incorporate my pulsing algo in our welders. Right now it's running on an Arduino in the lab, we need it included in next year's Welder XL4000 model." Actually doing the weld is just doing the job. So, back to software. What kind of coding is considered R&D and what is considered "just doing the job"? I guess creating new algorithms, or new features that you expect to be in the product for years to come; those would be R&D. Whereas fixing bugs, working on Kubernetes stuff, writing database backup routines, etc. would not be? I don't know. This is just my impression of the difference. I'm no economist.
        908B64B197 4y ago
        > So, back to software. What kind of coding is considered R&D and what is considered "just doing the job"? I guess creating new algorithms, or new features that you expect to be in the product for years to come; those would be R&D. Whereas fixing bugs, working on Kubernetes stuff, writing database backup routines, etc. would not be? I would still count the later as R&D. It's akin to having an industrial engineer re-design the manufacturing floor to accommodate for the different manufacturing process of the anodes. As soon as you need to customize something, it becomes R&D (else you would have purchased it). The "just the job" part is invisible because, well, it's the machine who's doing it (applications auto-start, install, send updates).
    - hellojesus 4y ago
      Welding stuff is developing a product. Basically the same thing software developers do. It seems like a nonsense differentiation if those are categorized differently for taxes.
      - TylerE 4y ago
        As some one who took a welding class.. no it isn’t. It’s production.
        bluGill 4y ago
        It can be development, if you are building a prototype for example. a good welder will notice that a bracket is missing and design one one the spot so the whole can be built for now - while telling the engineers about the problem. That is a small % of welding though. Most is just straight production work. The % is open to question - if I ask you to put a winch mount on my trailer how much of that is custom R&D, and how much is production of the one off product?
        maxerickson 4y ago
        If you have an off the shelf solution, then close to 0 development. If you have a clear, standard approach to the installation, then the development is likely to be a small portion of the work. If neither of those are true then you are in the hard to figure area.
        ikekkdcjkfke 4y ago
        A carpenter building a custom solution for room x A programmer building a custom abstraction for domain feature x A plumber laying a new line from the basement to the second floor All require some surveying and development of a solution, gluing existing parts together in a unique way
        maxerickson 4y ago
        Sure, I agree, but there are likely standard approaches, especially in the older trades, where the development is making ~1 decision and then measuring. Like if the carpenter is installing some shelves, they are most likely picking a shelving system or approach they know how to work with and measuring for fit, not coming up with a brand new way to mount shelves. They might come up with a new way, it just isn't all that likely.
- jdmichal 4y ago
  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!
  - dahfizz 4y ago
    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 https://www.law.cornell.edu/uscode/text/26/174
    - kaitai 4y ago
      What I find most confounding is that I know some folks who do what I'd call research, in that they do EDA and develop models, but since those aren't necessarily destined for development of software, their hours are not counted in this exercise. It's too, um, researchy to qualify as research, I guess? or it's just classified as fancy analytics.
      - zamnos 4y ago
        > and develop models The debate over whether Excel counts as programming and thus software development just got a lot more heated. The question is how is "software" defined in the context of the tax code, in particular in the phrase "development of any software" from above. https://www.lawinsider.com/dictionary/software https://www.lawinsider.com/dictionary/software gives a couple definitions.
    - pclmulqdq 4y ago
      The full IRS clarification on this will helpfully be available in a few months (a few months after the deadline), but it doesn't look like things like maintenance work will qualify, only new software projects. I'm expecting that a lot of savvy companies are going to decide that a lot of software development (using the common term) is not software development in the legal sense.
- deleted 4y ago
  [deleted]
- darth_avocado 4y ago
  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.
  - makeitdouble 4y ago
    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)
    - darth_avocado 4y ago
      Fair enough. If you made a million dollars and bought land with it, sure you can tax it. But something as basic as employee salaries that are a cost to any business should definitely be deductible from the profits as cost of running the business. Especially when the company is supposed to pay payroll taxes and the employees themselves pay income tax on their salaries.
      - makeitdouble 4y ago
        I'm with you in that it probably needs more nuance on what exaclty the developpers are doing (TBF I haven't read the details, so maybe there is already a lot of nuance in all of it.) I kinda see many cases where a salary isn't as clear cut as a simple cost...for instance comparing two cases: - we buy for a million dollar an exclusive right on an innovative system from a freelance guy that developed it on his own - we contract for 10k a month the same guy to design and develop the same innovative system, he takes a year or two to develop it. In one case it's a purchase of an asset, in the other case it's a salary. The resulting asset is the same though.
        tomrod 4y ago
- aikinai 4y ago
  Maintain services. Why was everyone expecting Twitter to go down after the layoffs if software developers only do research and development of new products?
ricardobayes 4y ago
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.
- indymike 4y ago
  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.
  - noughtme 4y ago
    ? Are you just framing up a mobile app for funzies? Wouldn't it be a professional service, therefore an expense, therefore fully tax deductible?
    - agwa 4y ago
      No, that's what's changing and it's why everyone is freaking out - software development is no longer a fully-deductible expense.
      - noughtme 4y ago
        Sorry, I couldn’t tell which side of the argument you were on, so I was curious if there were good reasons to defend the proposed change.
        indymike 4y ago
        There are none.
    - eldavido 4y ago
      No, this is completely wrong. It's not "just an expense". Think about an architect designing a house. The tax treatment depends on how the person spending the money "uses" the labor. It might be an ordinary operating expense (fully deductible), but could also be inventory, or a depreciated "capital asset" (closely related to the idea of "capital gains" taxes) whose value is spread over a long period of time, generally related to the asset's usable life. There is a large body of work around the correct treatment of this stuff, which sits at the core of accounting in the same way data structures sit at the core of CS. It's not the most straightforward thing to explain. The tax code contains a ton of exceptions, but in general, a thing that is long-lived, expensive, not routinely bought or sold, and provide some kind of long-lived economic benefit (e.g. shelter, the ability to produce something, or facilitate some kind of industrial process), is a capital asset. (Sounds a lot like software, doesn't it?) Inventory is something routinely bought and sold, generally for profit. A server is inventory for Dell. For a typical software startup, it's a capital asset. The whole point of accounting is trying to accurately measure economic activity. It's more complicated than it looks. If you agree to a five-year contract and get paid upfront, not all that money is "earned" (hence taxable) in the first year. If you're in debt and the debt is forgiven, no money changes hands, but that's very much beneficial (and taxable) to you. And if you own a long-lived asset, you don't just get to say, oh, I spent all this money upfront, that's an expense I can use to reduce my taxes. Not how it works. Just trying to shed some light on this. It is indeed rather complex.
mjwhansen 4y ago
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 https://www.law.cornell.edu/uscode/text/26/174 [2] https://www.forbes.com/sites/lynnmucenskikeck/2023/03/24/five-surprises-about-the-us-tax-research--experimental-capitalization-requirement/?sh=6329052351ae https://www.forbes.com/sites/lynnmucenskikeck/2023/03/24/fiv...
- fogzen 4y ago
  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.
  - dcow 4y ago
    This is my understanding as well. This whole issue seems rather… sensationalized.
    - 4y ago
1vuio0pswjnm7 4y ago
"I haven't yet gotten the answer for this each time this issue comes up." Asnwer: It's not mandatory.
- iamflimflam1 4y ago
  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.

cdot2 4y ago

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?

sangnoir 4y ago
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-application-of-the-process-of-experimentation-for-all-software https://www.irs.gov/businesses/audit-guidelines-on-the-appli...
- TylerE 4y ago
  > What would a welder do that isn't research or development? Weld stuff?
  - jdmichal 4y ago
    Isn't welding just "developing" metal products? That's why you have to take into account that it's "research and development", and not "research" and "development". As in research and the development of that research, not separately research and development.
    - function_seven 4y ago
      Yeah, forcing physical-world norms into technology will always result in weird shit like this. For the "real" world, Research would be studying different compounds to see which ones work well as anode or cathode. Development would be creating the industrial processes required to scale up manufacturing, or the ancillary infrastructure to support the new battery, or designing a new package for this awesome new cell. All the things that take the new thing from the lab to a marketable product. So if you come up with a new method for welding ("My new filler alloy reduces argon requirements by half!" or "My new pulsing methodology results in 23% stronger welds between dissimilar alloys.") That's Research. Then the Development of that might be "How do we manufacture these new filler rods to the exacting specs required?" or "We need to have the EE people incorporate my pulsing algo in our welders. Right now it's running on an Arduino in the lab, we need it included in next year's Welder XL4000 model." Actually doing the weld is just doing the job. So, back to software. What kind of coding is considered R&D and what is considered "just doing the job"? I guess creating new algorithms, or new features that you expect to be in the product for years to come; those would be R&D. Whereas fixing bugs, working on Kubernetes stuff, writing database backup routines, etc. would not be? I don't know. This is just my impression of the difference. I'm no economist.
      - 908B64B197 4y ago
        > So, back to software. What kind of coding is considered R&D and what is considered "just doing the job"? I guess creating new algorithms, or new features that you expect to be in the product for years to come; those would be R&D. Whereas fixing bugs, working on Kubernetes stuff, writing database backup routines, etc. would not be? I would still count the later as R&D. It's akin to having an industrial engineer re-design the manufacturing floor to accommodate for the different manufacturing process of the anodes. As soon as you need to customize something, it becomes R&D (else you would have purchased it). The "just the job" part is invisible because, well, it's the machine who's doing it (applications auto-start, install, send updates).
  - hellojesus 4y ago
    Welding stuff is developing a product. Basically the same thing software developers do. It seems like a nonsense differentiation if those are categorized differently for taxes.
    - TylerE 4y ago
      As some one who took a welding class.. no it isn’t. It’s production.
      - bluGill 4y ago
        It can be development, if you are building a prototype for example. a good welder will notice that a bracket is missing and design one one the spot so the whole can be built for now - while telling the engineers about the problem. That is a small % of welding though. Most is just straight production work. The % is open to question - if I ask you to put a winch mount on my trailer how much of that is custom R&D, and how much is production of the one off product?
        maxerickson 4y ago
        If you have an off the shelf solution, then close to 0 development. If you have a clear, standard approach to the installation, then the development is likely to be a small portion of the work. If neither of those are true then you are in the hard to figure area.
        ikekkdcjkfke 4y ago
        A carpenter building a custom solution for room x A programmer building a custom abstraction for domain feature x A plumber laying a new line from the basement to the second floor All require some surveying and development of a solution, gluing existing parts together in a unique way
        maxerickson 4y ago
        Sure, I agree, but there are likely standard approaches, especially in the older trades, where the development is making ~1 decision and then measuring. Like if the carpenter is installing some shelves, they are most likely picking a shelving system or approach they know how to work with and measuring for fit, not coming up with a brand new way to mount shelves. They might come up with a new way, it just isn't all that likely.
jdmichal 4y ago
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!
- dahfizz 4y ago
  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 https://www.law.cornell.edu/uscode/text/26/174
  - kaitai 4y ago
    What I find most confounding is that I know some folks who do what I'd call research, in that they do EDA and develop models, but since those aren't necessarily destined for development of software, their hours are not counted in this exercise. It's too, um, researchy to qualify as research, I guess? or it's just classified as fancy analytics.
    - zamnos 4y ago
      > and develop models The debate over whether Excel counts as programming and thus software development just got a lot more heated. The question is how is "software" defined in the context of the tax code, in particular in the phrase "development of any software" from above. https://www.lawinsider.com/dictionary/software https://www.lawinsider.com/dictionary/software gives a couple definitions.
  - pclmulqdq 4y ago
    The full IRS clarification on this will helpfully be available in a few months (a few months after the deadline), but it doesn't look like things like maintenance work will qualify, only new software projects. I'm expecting that a lot of savvy companies are going to decide that a lot of software development (using the common term) is not software development in the legal sense.
deleted 4y ago
[deleted]
darth_avocado 4y ago
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.
- makeitdouble 4y ago
  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)
  - darth_avocado 4y ago
    Fair enough. If you made a million dollars and bought land with it, sure you can tax it. But something as basic as employee salaries that are a cost to any business should definitely be deductible from the profits as cost of running the business. Especially when the company is supposed to pay payroll taxes and the employees themselves pay income tax on their salaries.
    - makeitdouble 4y ago
      I'm with you in that it probably needs more nuance on what exaclty the developpers are doing (TBF I haven't read the details, so maybe there is already a lot of nuance in all of it.) I kinda see many cases where a salary isn't as clear cut as a simple cost...for instance comparing two cases: - we buy for a million dollar an exclusive right on an innovative system from a freelance guy that developed it on his own - we contract for 10k a month the same guy to design and develop the same innovative system, he takes a year or two to develop it. In one case it's a purchase of an asset, in the other case it's a salary. The resulting asset is the same though.
      - tomrod 4y ago
aikinai 4y ago
Maintain services. Why was everyone expecting Twitter to go down after the layoffs if software developers only do research and development of new products?

ricardobayes 4y ago

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.

indymike 4y ago
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.
- noughtme 4y ago
  ? Are you just framing up a mobile app for funzies? Wouldn't it be a professional service, therefore an expense, therefore fully tax deductible?
  - agwa 4y ago
    No, that's what's changing and it's why everyone is freaking out - software development is no longer a fully-deductible expense.
    - noughtme 4y ago
      Sorry, I couldn’t tell which side of the argument you were on, so I was curious if there were good reasons to defend the proposed change.
      - indymike 4y ago
        There are none.
  - eldavido 4y ago
    No, this is completely wrong. It's not "just an expense". Think about an architect designing a house. The tax treatment depends on how the person spending the money "uses" the labor. It might be an ordinary operating expense (fully deductible), but could also be inventory, or a depreciated "capital asset" (closely related to the idea of "capital gains" taxes) whose value is spread over a long period of time, generally related to the asset's usable life. There is a large body of work around the correct treatment of this stuff, which sits at the core of accounting in the same way data structures sit at the core of CS. It's not the most straightforward thing to explain. The tax code contains a ton of exceptions, but in general, a thing that is long-lived, expensive, not routinely bought or sold, and provide some kind of long-lived economic benefit (e.g. shelter, the ability to produce something, or facilitate some kind of industrial process), is a capital asset. (Sounds a lot like software, doesn't it?) Inventory is something routinely bought and sold, generally for profit. A server is inventory for Dell. For a typical software startup, it's a capital asset. The whole point of accounting is trying to accurately measure economic activity. It's more complicated than it looks. If you agree to a five-year contract and get paid upfront, not all that money is "earned" (hence taxable) in the first year. If you're in debt and the debt is forgiven, no money changes hands, but that's very much beneficial (and taxable) to you. And if you own a long-lived asset, you don't just get to say, oh, I spent all this money upfront, that's an expense I can use to reduce my taxes. Not how it works. Just trying to shed some light on this. It is indeed rather complex.

mjwhansen 4y ago

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 https://www.law.cornell.edu/uscode/text/26/174 [2] https://www.forbes.com/sites/lynnmucenskikeck/2023/03/24/five-surprises-about-the-us-tax-research--experimental-capitalization-requirement/?sh=6329052351ae https://www.forbes.com/sites/lynnmucenskikeck/2023/03/24/fiv...

fogzen 4y ago
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.
- dcow 4y ago
  This is my understanding as well. This whole issue seems rather… sensationalized.
  - 4y ago

1vuio0pswjnm7 4y ago

"I haven't yet gotten the answer for this each time this issue comes up." Asnwer: It's not mandatory.

iamflimflam1 4y ago
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.