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I don’t understand why businesses can’t just say that their engineering department is a cost center (COGS) instead of classifying engineer salaries as R&D expen

by cj 3y ago

I don’t understand why businesses can’t just say that their engineering department is a cost center (COGS) instead of classifying engineer salaries as R&D expenditures. I guess one downside would be not qualifying for the R&D tax credit. The majority of software engineering is the equivalent of janitorial work… keeping servers online, fixing bugs, maintaining services, upgrading and refactoring code, etc. It’s difficult for me to tell how much of this issue is just people making a fuss about the literal interpretation of the tax code compared to how it will, in practice, impact their business. Nearly all accountants try to operate in the gray, in that accountants know how to tweak the numbers just enough to not get in big trouble with the IRS but enough that the business can slide through various loopholes. I have a feeling most accountants would just say “reclassify your engineers as maintenance workers, COGS” as a solution.

csdreamer7 3y ago
> I don’t understand why businesses can’t just say that their engineering department is a cost center (COGS) instead of classifying engineer salaries as R&D expenditures. They used to be able to. Then Trump and the Republicans came into power and changed it in 2017; the first year to be effective is 2022. https://bipartisanpolicy.org/blog/congress-is-running-out-of-time-to-fix-a-critical-rd-tax-issue-in-2023/ https://bipartisanpolicy.org/blog/congress-is-running-out-of... This was to help finance that 20% tax loophole as far as I understand it. https://www.nytimes.com/2018/08/08/us/politics/tax-deduction-pass-through-businesses.html https://www.nytimes.com/2018/08/08/us/politics/tax-deduction...
- cj 3y ago
  The article you linked to is about R&D. The point I was making is that software engineers don’t need to be classified as R&D. Why can’t a company lump engineers in the same category as technical support? (Which doesn’t need to be amortized)
  - gumby 3y ago
    Before the 2017 change you could and should have if they were not engaged in actual R&D. But people used to lump them into R&D anyway because of the preferential tax treatment (you also used to get special treatment for NOL, which you can't any more). Software development doesn't generally follow GAAP's model because unless you're IBM or Oracle the same people sometimes fix bugs and sometimes develop new features. The GAAP rules aren't insane: if your company buys a HQ building it's assumed to last 40 years. And since each year you "get some value" (e.g. you don't pay rent to someone else) you split the value of that purchase over 40 years. If you buy a computer you amortize it over 3 years because you're likely to "use it up" and replace it after that. And so if you're a car mfr you might have some people developing a new automatic transmission. You expect to then put those things into new cars for some time to come. So GAAP says the R&D that went into the new transmission is amortized while the cost of making one and sticking it into a car you sell is indeed COGS. If you're an early stage pharma startup almost all you do is R&D for quite a long time. For a software startup you can say the same thing: even if you ship your MVP, every bug you fix is turning it into the "real thing" (unlike Oracle, above, who can split maintenance and development into two buckets). So I favor accelerated recognition of R&D costs for startups. Not sure about established companies.
    - cj 3y ago
      I own a company with millions in payroll expense. All of payroll is lumped into 1 line item when submitted to the IRS. (I’m only somewhat simplifying for sake of argument) We would have to go out of our way to split out R&D. When you win $500 at a casino, do you go out of your way to claim the gain on your taxes? Absolutely not. Are you supposed to? Absolutely, but you don’t. And the IRS doesn’t much care. I feel like we’re talking past each other. The vast majority of companies won’t be paying more taxes because of this rule change.
      - gumby 3y ago
        Do you not keep your books according to GAAP either? If you make up your own accounting rules and it seems to work for you, well, more power to you. I like to have a clear understanding of where my business is going and the GAAP rules are pretty reasonable and align with other companies and what they do.
therealdrag0 3y ago
I’ve many years of experience over a variety of companies and none of my jobs were janitorial work. You’re describing SRE or intern work. Many many many Software engineers build things, especially in startups which is the focus of the discussion.
oldandboring 3y ago
> I don’t understand why businesses can’t just say that their engineering department is a cost center (COGS) instead of classifying engineer salaries as R&D expenditures. I spent a bunch of time on this last week with my experts-for-hire, as well as reading IRS guidance and 3rd party analyses. My understanding is: - Previously you could decide whether to capitalize/amortize your R&D expenses or not. Now you must capitalize/amortize. - Previously, you could choose to take the R&D credit for R&D activities, or not, regardless of whether you capitalized/amortized. That is still true. - Previously, software development was only considered an R&D activity in certain circumstances. Now, the IRS has "clarified" that they consider the process of software development to be so similar to the process of traditional R&D that it should nearly always be considered an R&D activity and therefore should be capitalized/amortized. One thing that's been frustrating is how, in discussions about this issue, software development is being spoken of nearly exclusively in the context of businesses developing software for themselves, either for internal use or resale. Left universally unmentioned are all the contractors, development shops, etc. who are developing software on a work-for-hire basis. How these companies should classify their engineers' work is not particularly clarified by the IRS guidance, but my understanding is that a consensus of "big" accounting firms is that these salaries should continue to be deducted as they were before.

by cj 3y ago

csdreamer7 3y ago

> I don’t understand why businesses can’t just say that their engineering department is a cost center (COGS) instead of classifying engineer salaries as R&D expenditures. They used to be able to. Then Trump and the Republicans came into power and changed it in 2017; the first year to be effective is 2022. https://bipartisanpolicy.org/blog/congress-is-running-out-of-time-to-fix-a-critical-rd-tax-issue-in-2023/ https://bipartisanpolicy.org/blog/congress-is-running-out-of... This was to help finance that 20% tax loophole as far as I understand it. https://www.nytimes.com/2018/08/08/us/politics/tax-deduction-pass-through-businesses.html https://www.nytimes.com/2018/08/08/us/politics/tax-deduction...

cj 3y ago
The article you linked to is about R&D. The point I was making is that software engineers don’t need to be classified as R&D. Why can’t a company lump engineers in the same category as technical support? (Which doesn’t need to be amortized)
- gumby 3y ago
  Before the 2017 change you could and should have if they were not engaged in actual R&D. But people used to lump them into R&D anyway because of the preferential tax treatment (you also used to get special treatment for NOL, which you can't any more). Software development doesn't generally follow GAAP's model because unless you're IBM or Oracle the same people sometimes fix bugs and sometimes develop new features. The GAAP rules aren't insane: if your company buys a HQ building it's assumed to last 40 years. And since each year you "get some value" (e.g. you don't pay rent to someone else) you split the value of that purchase over 40 years. If you buy a computer you amortize it over 3 years because you're likely to "use it up" and replace it after that. And so if you're a car mfr you might have some people developing a new automatic transmission. You expect to then put those things into new cars for some time to come. So GAAP says the R&D that went into the new transmission is amortized while the cost of making one and sticking it into a car you sell is indeed COGS. If you're an early stage pharma startup almost all you do is R&D for quite a long time. For a software startup you can say the same thing: even if you ship your MVP, every bug you fix is turning it into the "real thing" (unlike Oracle, above, who can split maintenance and development into two buckets). So I favor accelerated recognition of R&D costs for startups. Not sure about established companies.
  - cj 3y ago
    I own a company with millions in payroll expense. All of payroll is lumped into 1 line item when submitted to the IRS. (I’m only somewhat simplifying for sake of argument) We would have to go out of our way to split out R&D. When you win $500 at a casino, do you go out of your way to claim the gain on your taxes? Absolutely not. Are you supposed to? Absolutely, but you don’t. And the IRS doesn’t much care. I feel like we’re talking past each other. The vast majority of companies won’t be paying more taxes because of this rule change.
    - gumby 3y ago
      Do you not keep your books according to GAAP either? If you make up your own accounting rules and it seems to work for you, well, more power to you. I like to have a clear understanding of where my business is going and the GAAP rules are pretty reasonable and align with other companies and what they do.

therealdrag0 3y ago

I’ve many years of experience over a variety of companies and none of my jobs were janitorial work. You’re describing SRE or intern work. Many many many Software engineers build things, especially in startups which is the focus of the discussion.

oldandboring 3y ago

> I don’t understand why businesses can’t just say that their engineering department is a cost center (COGS) instead of classifying engineer salaries as R&D expenditures. I spent a bunch of time on this last week with my experts-for-hire, as well as reading IRS guidance and 3rd party analyses. My understanding is: - Previously you could decide whether to capitalize/amortize your R&D expenses or not. Now you must capitalize/amortize. - Previously, you could choose to take the R&D credit for R&D activities, or not, regardless of whether you capitalized/amortized. That is still true. - Previously, software development was only considered an R&D activity in certain circumstances. Now, the IRS has "clarified" that they consider the process of software development to be so similar to the process of traditional R&D that it should nearly always be considered an R&D activity and therefore should be capitalized/amortized. One thing that's been frustrating is how, in discussions about this issue, software development is being spoken of nearly exclusively in the context of businesses developing software for themselves, either for internal use or resale. Left universally unmentioned are all the contractors, development shops, etc. who are developing software on a work-for-hire basis. How these companies should classify their engineers' work is not particularly clarified by the IRS guidance, but my understanding is that a consensus of "big" accounting firms is that these salaries should continue to be deducted as they were before.