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> 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 so

by 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?
      - roflmao123 1y ago
        Two people earning $100k each would pay $28k income taxes each, totaling $56k. Where did this $80k come from?
        dyauspitr 1y ago
        What about state and city taxes? 80k might be a tad too high but in NYC on $100k, you would only take home around $65k.
    - maaaaattttt 1y ago
      And if it’s employees? Do you ask them to contribute to the company’s taxes as well? After they’ve paid their own?
      - roflmao123 1y ago
        You pay them less money so you can afford your taxes, like literally everyone else.
        spwa4 1y ago
        ... or you never have the startup, and just have 2 people unemployed and no produce nothing of use to anyone. Which is what's happening.
        roflmao123 1y ago
        If you can't afford your taxes your business model was flawed to begin with. In the above example there is more than enough money for it to still be worth doing.
- runeks 1y ago
  The amounts are irrelevant. It would be the exact same situation if all amounts were divided by e.g. 10: paying taxes on non-existent profits.
crystal_revenge 1y ago
This example only really has the emotional impact it does because of the specific numbers used, but doesn't really generalize for an arbitrary N. Clearly if two software engineers build a product that brings in $10M, and each pay themselves $5M, it doesn't seem so outrageous that the can't really claim they're running "a business that made literally no money." Clearly in this second example the problem is that the engineers are paying themselves way too high given the return on their efforts. What this means is that software engineers will be required to bring in more value to justify their high pay. In your example, it simply means that a software engineer that brings in $100,000 of value to the company, probably shouldn't be paid $100,000. This seems entirely reasonable to me, and doubly so when I consider how many large corporate teams (who I think will ultimately be impacted more than startups) has huge numbers of highly paid engineers not doing all that much. In most startups I've worked in it was pretty common for engineers to be delivering multiples of their cost in value, and in every big company I've worked in, it was very common to be delivering fractions of one's cost in value.
- spwa4 1y ago
  In case you don't understand: obviously you still pay income tax. What you suggest would mean you now pay income tax on that $10M, which is going to be 40% or even 50% depending, far higher than corporate tax. So with your suggested tactic the engineers get $2.55 million each. The rest, $4.5 million, is tax. If those 2 engineers paid themselves $0, and instead paid the $10 million as dividends, they'd get 4.25 million each, and only 1.5 million would be paid as tax. (Yes, this is a simplification, both situations are artificial and in both cases there'd be other taxes to pay, however, they'd be similar in both cases)
mcv 1y ago
Wait, salary costs do not count as costs for the year they're made in? That is completely nuts, no matter what kind of company you have. Although for a startup it might be least bad, because for their first few years, their revenue might well be closer to zero; they tend to burn money, sometimes for quite a while.
- jameshart 1y ago
  They count as costs, but towards a capital expense. The expectation is that that expenditure resulted in the creation of a valuable asset (and not one which was sold for $200,000). Revenue: $200,000 Expenses: -$200,000 Assets: $200,000 Net income: $200,000 You’re allowed to say ‘ah, but over the year the value of that $200,000 asset actually fell by 1/5’: Asset depreciation: -$40,000 So your net income is now $160,000 You owe taxes on that income.
  - dummydummy1234 1y ago
    But no matter what you are doing, your not spending 100% of your time building a piece of software. How does it work when a company uses salaried employees to build a structure. Are the salaried employees not deductible at all?
    - gortok 1y ago
      The IRS releases guidance on tax code, and one of the issues with section 174 taking effect in 2022 (and the IRS believing it would be repealed before it went into effect) was that the guidance was released in 2023 under notice 2023-63 https://www.irs.gov/pub/irs-drop/n-23-63.pdf https://www.irs.gov/pub/irs-drop/n-23-63.pdf To answer your question, the following are software development activities that are capitalizable (and instead of quoting the notice itself, I’m quoting from a better written blog post by accountants: https://www.cohnreznick.com/insights/additional-guidance-irs-section-174 https://www.cohnreznick.com/insights/additional-guidance-irs... > Section 4.03(1) of the Notice clarifies that labor costs – including those for contract employees and independent contractors – related to those who perform, supervise, or directly support SRE activities are considered Section 174 expenditures. All elements of compensation are to be included with the exception of severance, which is excludable and deducted by taxpayers in the period paid or incurred. SRE-related labor costs expenses included in the Notice expenses related to pension costs and stock-based compensation. Section 4.03(1)(e) provides guidance pertaining to certain costs related to operation and management (i.e., rent, utilities, etc.) activities. Specifically, in addition to items such as rent, utilities, and insurance, expenditures such as taxes (i.e., property), repairs and maintenance, and security are now considered SREs subject to Section 174. So what software development activities don’t count as “Specified Research Expenditures” (SRE)”? > Training of employees in the use of the software >Maintenance activities after the software is placed into service that do not constitute upgrades or enhancements (i.e., corrective maintenance to debug, diagnose, and fix programming errors) > Data conversion activities (except activities to develop computer software that facilitates access to existing data or data conversion) > Installation and other activities related to placing the software into service > Marketing and promotional activities > Distribution activities > Customer support If you’re a startup and you have a software developer doing the above activities as well as SRE work, then in order to expense the SRE parts of their job you either have to estimate (and be able to defend) the estimations, or your employee needs to track their time for each type of activity they do.

by gortok 1y ago

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?
    - roflmao123 1y ago
      Two people earning $100k each would pay $28k income taxes each, totaling $56k. Where did this $80k come from?
      - dyauspitr 1y ago
        What about state and city taxes? 80k might be a tad too high but in NYC on $100k, you would only take home around $65k.
  - maaaaattttt 1y ago
    And if it’s employees? Do you ask them to contribute to the company’s taxes as well? After they’ve paid their own?
    - roflmao123 1y ago
      You pay them less money so you can afford your taxes, like literally everyone else.
      - spwa4 1y ago
        ... or you never have the startup, and just have 2 people unemployed and no produce nothing of use to anyone. Which is what's happening.
        roflmao123 1y ago
        If you can't afford your taxes your business model was flawed to begin with. In the above example there is more than enough money for it to still be worth doing.
runeks 1y ago
The amounts are irrelevant. It would be the exact same situation if all amounts were divided by e.g. 10: paying taxes on non-existent profits.

crystal_revenge 1y ago

This example only really has the emotional impact it does because of the specific numbers used, but doesn't really generalize for an arbitrary N. Clearly if two software engineers build a product that brings in $10M, and each pay themselves $5M, it doesn't seem so outrageous that the can't really claim they're running "a business that made literally no money." Clearly in this second example the problem is that the engineers are paying themselves way too high given the return on their efforts. What this means is that software engineers will be required to bring in more value to justify their high pay. In your example, it simply means that a software engineer that brings in $100,000 of value to the company, probably shouldn't be paid $100,000. This seems entirely reasonable to me, and doubly so when I consider how many large corporate teams (who I think will ultimately be impacted more than startups) has huge numbers of highly paid engineers not doing all that much. In most startups I've worked in it was pretty common for engineers to be delivering multiples of their cost in value, and in every big company I've worked in, it was very common to be delivering fractions of one's cost in value.

spwa4 1y ago
In case you don't understand: obviously you still pay income tax. What you suggest would mean you now pay income tax on that $10M, which is going to be 40% or even 50% depending, far higher than corporate tax. So with your suggested tactic the engineers get $2.55 million each. The rest, $4.5 million, is tax. If those 2 engineers paid themselves $0, and instead paid the $10 million as dividends, they'd get 4.25 million each, and only 1.5 million would be paid as tax. (Yes, this is a simplification, both situations are artificial and in both cases there'd be other taxes to pay, however, they'd be similar in both cases)

mcv 1y ago

Wait, salary costs do not count as costs for the year they're made in? That is completely nuts, no matter what kind of company you have. Although for a startup it might be least bad, because for their first few years, their revenue might well be closer to zero; they tend to burn money, sometimes for quite a while.

jameshart 1y ago
They count as costs, but towards a capital expense. The expectation is that that expenditure resulted in the creation of a valuable asset (and not one which was sold for $200,000). Revenue: $200,000 Expenses: -$200,000 Assets: $200,000 Net income: $200,000 You’re allowed to say ‘ah, but over the year the value of that $200,000 asset actually fell by 1/5’: Asset depreciation: -$40,000 So your net income is now $160,000 You owe taxes on that income.
- dummydummy1234 1y ago
  But no matter what you are doing, your not spending 100% of your time building a piece of software. How does it work when a company uses salaried employees to build a structure. Are the salaried employees not deductible at all?
  - gortok 1y ago
    The IRS releases guidance on tax code, and one of the issues with section 174 taking effect in 2022 (and the IRS believing it would be repealed before it went into effect) was that the guidance was released in 2023 under notice 2023-63 https://www.irs.gov/pub/irs-drop/n-23-63.pdf https://www.irs.gov/pub/irs-drop/n-23-63.pdf To answer your question, the following are software development activities that are capitalizable (and instead of quoting the notice itself, I’m quoting from a better written blog post by accountants: https://www.cohnreznick.com/insights/additional-guidance-irs-section-174 https://www.cohnreznick.com/insights/additional-guidance-irs... > Section 4.03(1) of the Notice clarifies that labor costs – including those for contract employees and independent contractors – related to those who perform, supervise, or directly support SRE activities are considered Section 174 expenditures. All elements of compensation are to be included with the exception of severance, which is excludable and deducted by taxpayers in the period paid or incurred. SRE-related labor costs expenses included in the Notice expenses related to pension costs and stock-based compensation. Section 4.03(1)(e) provides guidance pertaining to certain costs related to operation and management (i.e., rent, utilities, etc.) activities. Specifically, in addition to items such as rent, utilities, and insurance, expenditures such as taxes (i.e., property), repairs and maintenance, and security are now considered SREs subject to Section 174. So what software development activities don’t count as “Specified Research Expenditures” (SRE)”? > Training of employees in the use of the software >Maintenance activities after the software is placed into service that do not constitute upgrades or enhancements (i.e., corrective maintenance to debug, diagnose, and fix programming errors) > Data conversion activities (except activities to develop computer software that facilitates access to existing data or data conversion) > Installation and other activities related to placing the software into service > Marketing and promotional activities > Distribution activities > Customer support If you’re a startup and you have a software developer doing the above activities as well as SRE work, then in order to expense the SRE parts of their job you either have to estimate (and be able to defend) the estimations, or your employee needs to track their time for each type of activity they do.