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What are the implications of this. As I understand accounting, this means that reported profits would be higher, and therefore incur more corporate income tax

by netcan 1y ago

What are the implications of this. As I understand accounting, this means that reported profits would be higher, and therefore incur more corporate income tax liability. Cash flow isn't effected besides tax. A startup isn't likely to be making a profit yet, under either accounting rule. Is there a benefit to reporting a larger loss? My first thought is that this effects Google and suchlike, not startups. But... assuming steady state "r&d" expenditure... it's not that much. Everything gets deducted within 5 years anyway. So... maybe this hinders more modestly profitable, and fast growing companies most. Those that can't afford to carry 5 years worth of paper profits as easily. Otoh... I am curious about how the difference between r&d expenses and operational ones are determined irl. This should be quantifiable. How much extra assets are software companies actually booking? It seems questionable that this "silent killer" had actually affected employment so much.

calderwoodra 1y ago
I'm not an accountant, but as I understand it, you don't pay taxes on profits, but on revenue. So previously, some 20% of all revenue would be owned as corporate income tax, and startups would deduct it all as they're spending much more on R&D than they owe in corporate income tax. But with this tax change, the deduction would be much lower (80% lower IIUC).
- testrun 1y ago
  No, you pay taxes on profits. What this does is reduce your upfront deduction.
  - epr 1y ago
    Yes, but the main thing here is that ALL software development is now "profit" in the short term. In theory you've developed a capital good that benefits you over time, hence the amortization. Simplified 2021 example before 174: 100k Revenue 100k Software Dev Costs No profit or tax Simplified 2022 example after 174: 100k Revenue 100k Software Dev Costs 90k "profit" 18.9k taxes Above example is year one of suddenly having these taxes, because if your software costs are the same or lower over time it gets easier. It's just extremely painful for smaller and especially fast growing companies like startups without a lot of cash, especially when interest rates are so high. Accountants: If I am wrong about the above, please correct me
    - testrun 1y ago
      The profit is 80k, not 90k, but the principle is correct. This will affect cash flow.
- mrweasel 1y ago
  If companies paid tax on revenue the US budget would be perfectly fine.
  - rbultje 1y ago
    Large companies always find a way to not pay taxes. It's the little guys that end up paying (a lot!) more, to the extend that it cripples and kills them. But transformative innovation happens with the little guys. As a result, this tax change cements monopolies for megacorps. They will be fine and still pay nothing.
    - datavirtue 1y ago
      The little guy always pays all taxes. Corporate tax is just a way to palatably shift tax burden to the low and middle classes and away from the owner class. It is pure double speak.
      - jazzypants 1y ago
        Then, why do rich people lobby so hard against any attempt to raise their taxes? This is reductive and frankly stupid.
  - cyberax 1y ago
    Yeah. Let's bankrupt grocery stores that operate with margins measured in single percents. If that.
  - nayuki 1y ago
    If companies paid tax on revenue, then there would be a tremendous incentive toward https://en.wikipedia.org/wiki/Vertical_integration https://en.wikipedia.org/wiki/Vertical_integration , because you wouldn't be allowed to deduct the expenses paid to your suppliers.
- akoboldfrying 1y ago
  > you don't pay taxes on profits, but on revenue. That can't be right. It definitely isn't in my country. If own a car dealership, and I sell a car for $50,000 that I bought from the manufacturer for $40,000, surely I would pay tax on the $10,000 profit? The tax on the the full $50,000 revenue might exceed my profit!
  - billy99k 1y ago
    Welcome to the Democrat version of taxes. In Michigan, restaurant owners had to pay a tax on revenue and not profit around 2008 or so. lots of retaurants went out of business overnight.
    - hollerith 1y ago
      Sales tax (which most US states collect) specifically is a tax on revenue, but it is the exception.
    - int_19h 1y ago
      When taxes are paid on revenue rather than profits, the rate is obviously much lower, so that it would add up to roughly the same thing. However, there are many benefits overall. For one, it completely kills off the various convoluted schemes to avoid classifying something that is obviously a profit as such (by shuffling things around subsidiaries etc, for example). See also: Hollywood accounting.
- speakfreely 1y ago
  I am so interested in what business you work in that you would think this could be true.
juliennakache 1y ago
The R&D credits are deducted from Payroll taxes, so they impact pre-revenue startups as well.
fauigerzigerk 1y ago
That was my first thought as well, but on second thought I can see how this might cause problems: For established profitable software companies there was a cliff edge in 2022 when this change kicked in. Staff costs for previous years had already been fully expensed while only 20% of the current year's costs could be deducted. Second, any sudden increase in research expenditures is now discouraged. This could make companies less nimble. For unprofitable startups it could cause issues during a phase of very high revenue growth. They could suddenly be liable to pay corporation tax in spite of the fact that they are not profitable in any reasonable sense of the word. It would smooth out later, but that may be too late for some. What I do not believe for a second is that this is causing major job losses. Companies like Microsoft or Meta do not reduce research or software development just because there is a temporary tax hit. It could be an extra incentive for an efficiency drive I guess.
- netcan 1y ago
  > For unprofitable startups it could cause issues during a phase of very high revenue growth. So I guess my most question is "how this work irl?" Say a new startup raises money and hires 20 people. Pays $5m in salaries, office space and such. All 20 people are developing a software product. Are 100% of this startups expenses amorotized? Then they sell the product. They receive $2m in revenue. What does the P&L look like.
  - t0mas88 1y ago
    1 million profit, while they have 3 million negative cashflow, that's exactly the problem. They can only take 20% of that 5 million in R&D investment as depreciation in the first year.
  - fauigerzigerk 1y ago
    If they hire 20 devs in their first year paying $5m in salaries, only $1m or $500k (if the mid-year convention applies) would count as a business expense in that first year. If their revenue was $2m, that would leave them with $1m (or $1.5m) of taxable profits unless that was eaten by other costs. It doesn't have to be a problem, but if revenue grows fast and they go on another hiring spree in the following year then it could become a problem. That said, if revenue grows so fast, it seems likely that they would have huge marketing and sales costs that could be expensed immediately. So maybe this isn't really a problem for many startups. I'm not sure.
freeone3000 1y ago
Your analysis is correct, but most software companies were mostly profitable or fast-growing. For every Google, there’s 1000 wordpress vendors you’ve never heard of. In another year the initial shock will stabilize, but any growth now has a 5-year tax hit attached. And even Facebook doesn’t want to pay that if it doesn’t have to.
Klonoar 1y ago
Google was reportedly amortizing (by choice) long before this was in effect, so while it might “affect them”, in practice it’s likely business as usual.
- nostrademons 1y ago
  It depends on the department. My salary (in a mature product) was already amortized - I suspect the same is true of all their other mature products like Search, Maps, GMail, Chrome, YouTube, etc. But I think they were deducting salaries in the more research-like areas like Gemini, Jax, Assistant, etc. So there is net still a fairly large charge related to it, even if it isn't as large as it could be.
  - Tokumei-no-hito 1y ago
    pardon my ignorance but why would they amortize some and not others?
    - tmp10423288442 1y ago
      - In a steady state where you're spending the same amount every year, the tax burden of amortized vs. unamortized accounting makes no difference. It only matters for R&D - i.e., new products. - I read once, although I have no idea how accurate this is, that a company could classify maintenance expenses (i.e., paying SREs and some SWEs to keep the service running and fix bugs) as non-R&D and therefore be able to amortize. That's another advantage to mature services over new services.
gortok 1y ago
> A startup isn't likely to be making a profit yet, under either accounting rule. Is there a benefit to reporting a larger loss? As an example, A two person software startup; both drawing a salary, each making $100,000 per year. Each doing things related to software development. Startup brings in 200,000K in revenue. Under pre Section 174 changes, the profit is zero. Both salaries are expensible in the year they were incurred. Post Section 174, the profit is now $160,000 each year. Now they pay taxes on $160,000, even though they literally have no money left over because revenues equaled expenditures. At 25% tax rate, that’s $40,000 in taxes, for a business that made literally no money. That’s why this is so devastating to small software businesses; unless you’re highly profitable and have cash reserves, this change hits hard.
- datavirtue 1y ago
  Yeah, this provision is a complete fuck up.
- roflmao123 1y ago
  > Post Section 174, the profit is now $160,000 each year. Now they pay taxes on $160,000, even though they literally have no money left over because revenues equaled expenditures. They have the $200k they pulled from their startup, far more than what most people earn. If you make enough to pay yourself $100k then you make enough to pay taxes.
  - ccleve 1y ago
    They do pay taxes. They each pay personal income tax on their $100k.
    - roflmao123 1y ago
      Still plenty left to pay their business taxes.
      - dyauspitr 1y ago
        So on the $200,000 it’s reasonable to you that they have to pay $120,000 ($80k income+$40k business) in taxes?

by netcan 1y ago

calderwoodra 1y ago

I'm not an accountant, but as I understand it, you don't pay taxes on profits, but on revenue. So previously, some 20% of all revenue would be owned as corporate income tax, and startups would deduct it all as they're spending much more on R&D than they owe in corporate income tax. But with this tax change, the deduction would be much lower (80% lower IIUC).

testrun 1y ago
No, you pay taxes on profits. What this does is reduce your upfront deduction.
- epr 1y ago
  Yes, but the main thing here is that ALL software development is now "profit" in the short term. In theory you've developed a capital good that benefits you over time, hence the amortization. Simplified 2021 example before 174: 100k Revenue 100k Software Dev Costs No profit or tax Simplified 2022 example after 174: 100k Revenue 100k Software Dev Costs 90k "profit" 18.9k taxes Above example is year one of suddenly having these taxes, because if your software costs are the same or lower over time it gets easier. It's just extremely painful for smaller and especially fast growing companies like startups without a lot of cash, especially when interest rates are so high. Accountants: If I am wrong about the above, please correct me
  - testrun 1y ago
    The profit is 80k, not 90k, but the principle is correct. This will affect cash flow.
mrweasel 1y ago
If companies paid tax on revenue the US budget would be perfectly fine.
- rbultje 1y ago
  Large companies always find a way to not pay taxes. It's the little guys that end up paying (a lot!) more, to the extend that it cripples and kills them. But transformative innovation happens with the little guys. As a result, this tax change cements monopolies for megacorps. They will be fine and still pay nothing.
  - datavirtue 1y ago
    The little guy always pays all taxes. Corporate tax is just a way to palatably shift tax burden to the low and middle classes and away from the owner class. It is pure double speak.
    - jazzypants 1y ago
      Then, why do rich people lobby so hard against any attempt to raise their taxes? This is reductive and frankly stupid.
- cyberax 1y ago
  Yeah. Let's bankrupt grocery stores that operate with margins measured in single percents. If that.
- nayuki 1y ago
  If companies paid tax on revenue, then there would be a tremendous incentive toward https://en.wikipedia.org/wiki/Vertical_integration https://en.wikipedia.org/wiki/Vertical_integration , because you wouldn't be allowed to deduct the expenses paid to your suppliers.
akoboldfrying 1y ago
> you don't pay taxes on profits, but on revenue. That can't be right. It definitely isn't in my country. If own a car dealership, and I sell a car for $50,000 that I bought from the manufacturer for $40,000, surely I would pay tax on the $10,000 profit? The tax on the the full $50,000 revenue might exceed my profit!
- billy99k 1y ago
  Welcome to the Democrat version of taxes. In Michigan, restaurant owners had to pay a tax on revenue and not profit around 2008 or so. lots of retaurants went out of business overnight.
  - hollerith 1y ago
    Sales tax (which most US states collect) specifically is a tax on revenue, but it is the exception.
  - int_19h 1y ago
    When taxes are paid on revenue rather than profits, the rate is obviously much lower, so that it would add up to roughly the same thing. However, there are many benefits overall. For one, it completely kills off the various convoluted schemes to avoid classifying something that is obviously a profit as such (by shuffling things around subsidiaries etc, for example). See also: Hollywood accounting.
speakfreely 1y ago
I am so interested in what business you work in that you would think this could be true.

juliennakache 1y ago

The R&D credits are deducted from Payroll taxes, so they impact pre-revenue startups as well.

fauigerzigerk 1y ago

That was my first thought as well, but on second thought I can see how this might cause problems: For established profitable software companies there was a cliff edge in 2022 when this change kicked in. Staff costs for previous years had already been fully expensed while only 20% of the current year's costs could be deducted. Second, any sudden increase in research expenditures is now discouraged. This could make companies less nimble. For unprofitable startups it could cause issues during a phase of very high revenue growth. They could suddenly be liable to pay corporation tax in spite of the fact that they are not profitable in any reasonable sense of the word. It would smooth out later, but that may be too late for some. What I do not believe for a second is that this is causing major job losses. Companies like Microsoft or Meta do not reduce research or software development just because there is a temporary tax hit. It could be an extra incentive for an efficiency drive I guess.

netcan 1y ago
> For unprofitable startups it could cause issues during a phase of very high revenue growth. So I guess my most question is "how this work irl?" Say a new startup raises money and hires 20 people. Pays $5m in salaries, office space and such. All 20 people are developing a software product. Are 100% of this startups expenses amorotized? Then they sell the product. They receive $2m in revenue. What does the P&L look like.
- t0mas88 1y ago
  1 million profit, while they have 3 million negative cashflow, that's exactly the problem. They can only take 20% of that 5 million in R&D investment as depreciation in the first year.
- fauigerzigerk 1y ago
  If they hire 20 devs in their first year paying $5m in salaries, only $1m or $500k (if the mid-year convention applies) would count as a business expense in that first year. If their revenue was $2m, that would leave them with $1m (or $1.5m) of taxable profits unless that was eaten by other costs. It doesn't have to be a problem, but if revenue grows fast and they go on another hiring spree in the following year then it could become a problem. That said, if revenue grows so fast, it seems likely that they would have huge marketing and sales costs that could be expensed immediately. So maybe this isn't really a problem for many startups. I'm not sure.

freeone3000 1y ago

Your analysis is correct, but most software companies were mostly profitable or fast-growing. For every Google, there’s 1000 wordpress vendors you’ve never heard of. In another year the initial shock will stabilize, but any growth now has a 5-year tax hit attached. And even Facebook doesn’t want to pay that if it doesn’t have to.

Klonoar 1y ago

Google was reportedly amortizing (by choice) long before this was in effect, so while it might “affect them”, in practice it’s likely business as usual.

nostrademons 1y ago
It depends on the department. My salary (in a mature product) was already amortized - I suspect the same is true of all their other mature products like Search, Maps, GMail, Chrome, YouTube, etc. But I think they were deducting salaries in the more research-like areas like Gemini, Jax, Assistant, etc. So there is net still a fairly large charge related to it, even if it isn't as large as it could be.
- Tokumei-no-hito 1y ago
  pardon my ignorance but why would they amortize some and not others?
  - tmp10423288442 1y ago
    - In a steady state where you're spending the same amount every year, the tax burden of amortized vs. unamortized accounting makes no difference. It only matters for R&D - i.e., new products. - I read once, although I have no idea how accurate this is, that a company could classify maintenance expenses (i.e., paying SREs and some SWEs to keep the service running and fix bugs) as non-R&D and therefore be able to amortize. That's another advantage to mature services over new services.

gortok 1y ago

> A startup isn't likely to be making a profit yet, under either accounting rule. Is there a benefit to reporting a larger loss? As an example, A two person software startup; both drawing a salary, each making $100,000 per year. Each doing things related to software development. Startup brings in 200,000K in revenue. Under pre Section 174 changes, the profit is zero. Both salaries are expensible in the year they were incurred. Post Section 174, the profit is now $160,000 each year. Now they pay taxes on $160,000, even though they literally have no money left over because revenues equaled expenditures. At 25% tax rate, that’s $40,000 in taxes, for a business that made literally no money. That’s why this is so devastating to small software businesses; unless you’re highly profitable and have cash reserves, this change hits hard.

datavirtue 1y ago
Yeah, this provision is a complete fuck up.
roflmao123 1y ago
> Post Section 174, the profit is now $160,000 each year. Now they pay taxes on $160,000, even though they literally have no money left over because revenues equaled expenditures. They have the $200k they pulled from their startup, far more than what most people earn. If you make enough to pay yourself $100k then you make enough to pay taxes.
- ccleve 1y ago
  They do pay taxes. They each pay personal income tax on their $100k.
  - roflmao123 1y ago
    Still plenty left to pay their business taxes.
    - dyauspitr 1y ago
      So on the $200,000 it’s reasonable to you that they have to pay $120,000 ($80k income+$40k business) in taxes?