IRS tax code change in Section 174: R&D is an expense

It's not bad for the entire nation, though, right? Wasn't the change made to compensate for the Trump tax cuts? Someone somewhere else did benefit, mainly the top bracket, especially folks in states not really affected by SALT, and some in the bottom brackets (due to a higher standard deduction). Unless I'm misremembering or missing something.

Another change in recent years that mostly affected some tech companies was making free employee meals taxable.

It got a lot of discussion last year, and when the law was originally passed.

By now, it's old news for both the tax and tech communities.

The author does cover this point, further in the thread.

> An example:

> A company has $1.2M in revenue; and $1M in costs (let's assume all costs are employing devs fulltime).

> Before 2022: the profit of the company is $200K. Pays corporate tax on this.

> In 2022: the profit of the company is $1M (of the $1M in salaries paid for devs, this needs to be amortized over 5 years: so $200K can be amortized for the year). Need to pay corproate tax on this. But the business might not have this much cash on hand, and so needs to borrow at a high interest rate. MASSIVE change!

> ... and so now companies are incentivized to have as little R&D expenses as possible (aka fire fulltime devs doing R&D, unless they can front the 5-year spread).

https://twitter.com/GergelyOrosz/status/1735037956438523984

The tweet is correct.

In fact, page 2 , paragraph 1 of the IRS doc you linked to actually uses some of the same wording as the tweet does:

* (1) Former § 174(a)(1) provided that a taxpayer may treat research or experimental expenditures which are paid or incurred by the taxpayer during the taxable year in connection with the taxpayer’s trade or business as expenses which are not chargeable to capital account. The expenditures so treated were allowed as a deduction. *

While I would agree that the tweet's wording could have been better - and your quote is clearer - the tweet above is not wrong.

Ok but assuming equal software dev (or R&D) expenditures over time, for the first four years after this law takes effect, you will be paying more taxes. You've gone from being able to expense 100%, to only 20% in the first year, then 40%, then 60%, then 80%, then finally 100% again on year five.

That's the change, salaries can no longer be counted against revenue in the same year and has to be amortized. For tax purposes, you now have a profit of $1M (1.2M of revenue - (1M of salary * 0.2)). This makes sense for assets right, if you buy an excavator worth $1M you shouldn't be allowed to count that all against your profit because you still have ~$1M worth of excavator you could sell or something, but it doesn't make sense when applied to salaries.

EDIT: It's actually a little worse than this, you can only amortize 10% on the first year

I mean you might considered a loaded gun to be a gun with bullets in it but by most laws if you hold the bullets in the left hand and the gun in the right hand that's a loaded gun. The law needent be consistent with common understanding.

So, in lets say 2023 your business brings in $1.2M of revenue from a pure-software product. Your net cashflow is $0.2M because you paid $1M to the dev team. Come tax time you have to report a revenue of $1.2M and the maximum allowed expenses are $0.2M so you have to pay taxes on that $1M of profit.

The reason the maximum allow expenses are $0.2M is because Software is considered R&D now so the expenses towards it (the $1M in salary) _must_ be amortized over 5 years. So if next year you also had $1.2M of revenue and $1M of salaries you'd be paying profit on $1.2 - 2 * ($0.2M) since there's two years of salaries be amortized now.

The 2017 law changed the way software development expenses are counted for tax purposes. 2023 taxes are the first taxes this rule affects.

Details:

https://www.onlycfo.io/p/new-tax-rule-is-terrible-for-softwa...

> Your product is software, so that could be viewed as COGS

the production of the software could be either the copying of the bits, rather than the writing of the code.

For example, in the case of the novelist, is the cost of sale of a book the cost of printing and distribution? the writing of the book is not a COGS cost.

This law has a specific provision (and the IRS issued even more guidance confirming it) defining that all expenses related to software development are covered by section 174 and count as R&D. This includes labor costs for not just the developers themselves, but also anyone managing or supervising them, as well as any related benefits or costs of materials and supplies.