Thousands of small businesses are struggling because of R&D amortization
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There is a minor win that was just advanced in the House yesterday[0] to delay US onshore amortization through 2025 via The Tax Relief for American Families and Workers Act of 2024[1]. It doesn't touch offshore amortization.
It's not enough. I was geared up to start a business this year; this, specifically, has put the brakes on it. I've written as much to my congressional representatives. I'm doing research into what it would take to incorporate in another country, and the implications therein, if it comes to that.
I'm going to sign up to https://ssballiance.org/, as telesilla recommended.
Let's beat the drum together, folks.
[0] https://www.voanews.com/a/7448071.html
[1] https://www.finance.senate.gov/imo/media/doc/the_tax_relief_...
edit: formatting
I've read a little about this, but not a lot. How has this put sufficient drag on starting a business that it's impractical to go from zero to one? Is there an aspect of the business model that's particularly impacted?
Is there a good chance of recategorization pushing a very marginal business off the cliff? Sure--that Twitter thread, where there are enough details to read in, has a lot of examples of marginal businesses having trouble (mostly because of not being able to plan in the change, which really sucks). But you don't have that on day zero, and going in with the aim to be that very marginal business is probably not the best of ideas. It's not a day-zero problem, and I am struggling to see where a small business with a business plan that was previously worth executing on is now not worth it because of this change.
To slightly simplify: it forces startups to pay taxes on profits that only exist on paper, with cash that is now much more scarce
For a clearer picture on this it’s helpful to include the actual tax amount. With a corporate rate of 21%, the tax would be about $12K.
Now that’s not zero, but it better shows the actual cost born in year one under this plan.
The later years are important as well. As profits continue to flow in, the rest of the cost can be deducted from it. So it doesn’t disappear.
Though you do lose a bit from the nature of present nominal being inherently worth more than future nominal amount. With todays higher rates, that’s an even larger factor.
Affected small businesses suddenly need to increase revenue or cut costs by 20% just to keep their business solvent. Most small businesses do not have the structural elasticity or capital reserves to absorb that, nor do many business plans. In the very long term it notionally all evens out but most small businesses don't survive that long and these large new costs of doing business will reduce the survival rate even further.
For mature companies, it all evens out, because you write off the costs over 5 years and it's just a blip. You can just borrow that money as a corporate bond, creating a real but manageable cost. For growing companies, it's forcing you to set aside money now (in the form of a tax deduction) you won't get back until year 5. So your burn rate is going up. And, unlike a mature company where the cost decreases over time (by year 5 it was a one time blip), that's only to the degree your salary costs have been stable for five years. Every time you scale up engineering staff, it puts you more in the hole for another five years.
For public companies, they are incentivized to amortize over longer period because it hides expenses and can boost earnings that boosts stock price.
If any property with respect to which specified research or experimental
expenditures are paid or incurred is disposed, retired, or abandoned
during the period during which such expenditures are allowed as an amortization
deduction under this section, no deduction shall be allowed with respect to
such expenditures on account of such disposition, retirement, or abandonment
and such amortization deduction shall continue with respect to such expenditures.But if the typical lifetime is 5 years, but you use an ADS of 2 years... you are not disposing or abandoning the asset if you keep it for 2 years. 2 years is the expected life time of the asset, and at the end of year 2, the asset has a value of $0.
If you depreciate over 5 years, but then on year 2 decide you don't need the asset anymore, then you'll dispose of it. The asset is valued at 3/5ths of the original price. The paragraph you're quoting applies to this scenario.
ADS doesn't apply here though, because TCJA requires 5 years for domestic and 15 years for foreign research.
This pdf has handy chart to determine how to determine software development should be treat for accounting purposes. Grant Thornton is the external auditor for many large companies.
ttps://www.grantthornton.com/content/dam/grantthornton/website/assets/content-page-files/audit/pdfs/2020/accounting-software-costs/accounting-software-costs.pdf
https://www.grantthornton.com/insights/alerts/tax/2023/flash...
This seems to contradict your statement that “all software development costs [are] to be treated as r&d,” but my experience is that you know what you’re talking about. What am I missing here?
For example, for a new feature: if you plan (SRE), design the interface (SRE), write the feature (SRE), run it through QA (SRE), and then discover a bug and correct it -- that's still SRE.
If you put the software into prod, then discover a bug, then fix it (without improving performance or adding any functionality), then it might not be SRE.
But if you sell software, and you sell or install a release to a customer, and they (or you, under a support contract) discover a bug and fix it... but then you include the fix in your next release, probably SRE.
Or, if you put the software into prod, discover it breaks with a large data set, and you fix it by improving the performance of that section of code, probably SRE.
The expenses falling under that provision aren't going to make a significant change to the impact of TCJA on software development.
(Disclaimer: not seeking tax advice or legal advice, we’re just two dudes casually discussing section 174 like normal people do all the time).
That notice was a helpful read. I think what I may have been missing was section 5 of Rev. Proc. 2000-50, whereunder non-SRE software dev was also afforded some similar protection. I’ll read that after work but I’d still love you to answer the foregoing.
Definitely ask your CPA though. I'm not an accountant.
Bro what? Were you starting the business specifically to get these deductions? (I’m genuinely curious, sounds like a fun regulatory arbitrage.)
Michele Hansen is doing an incredible job here and should be recognized for it. Latest news was sent yesterday:
Republicans and Democrats finally struck a tax deal that includes a partial fix for Section 174. It includes expanding the Child Tax Credit, a key Democratic priority, with a handful of business tax issues where were Republican priorities...
Not sure if there is a public copy of that email, but the core info is on the site, it has a list of ways to get your representative's attention and a script to follow. Please call.
That’s a bit too “must make it seem bipartisan” when there is a clear partisan direction.
Even when this fix is passed, it will be voted for unanimously by Democrats and only a small fraction of Republicans will vote for it.
Explain again to me how that makes it a Republican priority as opposed to a priority of the endangered species that is the Pro Business Republicans?
Like the unanimous democrat vote to repeal the SALT limits that overwhelming impacts people in California and NY?
On what basis will it be different here? Dems are almost completely disengaged on the bill intended to fix this, almost all the activity for and against appears to be republicans.
Addicted's confident statement "Even when this fix is passed, it will be voted for unanimously by Democrats" seems misplaced and unlikely. If that were likely we would have seen broad dems support on fixing the SALT tax limits and we just didn't.
I wish there was a good way to prevent such behavior.
https://www.cnbc.com/2024/01/19/bipartisan-tax-bill-clears-k...
The strong bipartisan showing in the House Ways and Means Committee adds more momentum to the proposed changes, which include allowing the immediate expensing of research and development costs.
Going on a tangent here, but I always hated this idea of reading off a script to try and lobby politicians. If I were the politician, I would ignore all such communiques as indoctrinated spam.
Now for tweets, it’s important that each tweet is unique. Otherwise it’s clearly coordinated/automated. But as a casual scroll of Twitter shows, many people hate comfortable expressing themselves through that medium.
Also, I kinda wrote a whole book with scripts (for customer interviewing)… if I didn’t provide scripts, it just wouldn’t be true to my work!
It moves the calculus of measuring sentiment from a fuzzy game of figuring out how to classify opinion to one with very clear quanta.
Here’s a simplified example of this works: Let’s say you’re a four person software dev startup. Everybody is making, say, $125K to get by. That’s $500K in salary expense which normally you can write off as expenses against revenue/funding. For this example, let’s say somehow you also generated $500K in revenue/funding, i.e. you just broke even.
Currently, you would (of course) owe zero taxes. Under the new tax rules, you couldn’t write off those R&D salaries as expenses, only amortize them over 5 years. That is, your salary expenses for this year is only ~ $100K, and this you made a $400K ‘profit’ (!!) on which you owe taxes ($100K).
In terms of tax, should we average out these expense over the years?
These can have huge difference because how complex our tax and accounting rules are.
It seems like the IRS is trying to speculatively tax unrealized future profits here, and that's pretty unconscionable.
We once started a revolution over unfair taxation. I sadly think the same will be necessary to fix the status quo, as system has rotted past the point of meaningful reform.
On top of that, the necessity of shoehorning everyone's economic activity into prescriptive taxonomies in order to implement this taxation has drastically diminished innovation on the margin, and has created unintended consequences that significantly distort market incentives and diminish our ability to adapt to change, with the situation we're discussing here being a prime example.
I'm worried that you're right; that it's beyond repair, and that we may have to live through a systemic collapse before things can get better.
It's just as if you pay the salaries of some construction workers to build you a new factory - those salaries are part of the capital investment for creating that factory (and depreciated as that asset), not your operating expenses.
Note that in year 2, you get 20% of the year 2 salary expense, plus 20% from year 1. So the impact is less. By year 5 you are "caught up".
Indeed the first years are harder.
incentivized by quota but the incentive is there to get it on the books.
there is no forgery involved.
Yes, of course as you increase spend you increase the impact (in the year that you actually spent), but the context here is specifically very early SMBs, and more so, ones that would only be running break even under previous rules.
obviously if you pay salary in December, you paid in December and you have to book it that way.
It doesn't matter if $500k/$500k is good or bad. They're only numbers that simplify the point without misrepresenting the situation.
It does suck that a quirk in accounting means you were profitable on the books, no question there. But it "just" means you can't run so close to the bone. I don't think it's the world ender everyone is making it out to be. It means you need more operating capital up front.
>> lots of devs in Switzerland starts to make a lot more sense, especially now.
This seems contradictory.
In many European countries you have to file a ton of paperwork and justify it: ex. at Google, they're still working through _January 2023_ layoffs because you have to work with the government itself and there isn't a good* financial reason for it
* by European standards. "we need stonk to go up" doesn't fly if you're massively profitable
That's an internal choice they do, to avoid having a reputation of a company that fires people any second (but then you have companies like netflix which take pride in having that reputation, but make up for it by paying more).
However, it's very different from European companies where these processes are (often) driven by laws. In the US there are no employee protection laws (aside from protected classes) so even if the company has a rigorous internal process, they could at any second override it if someone high up says so and you'll be fired in the blink of an eye.
One of the reasons Google has long term big center in Zurich, if grass would be greener (since cheaper it is) in say Germany or Austria they would build there
I don't think Google has an office in Zurich because it's cheap. It's mostly due to a lot of talent available (ETHZ, EFPL, etc).
You get 70% of your salary (or 80% if you have children under 25) for two years, capped at 70% (or 80%) of 150k.
There are a lot more exceptions, special cases and so on, but that's the gist of it.
Here in Virginia, the max, regardless of how much you made, is $378/wk, for a max of 12 weeks.
You can't claim it if you're also receiving a severance, and you also have to record at least 4 job applications each week, but the documentation required needs to include information like the hiring manager's full contact information, which usually means the company needs to have replied to your application within that week.
I got laid off back at the end of April last year. I got a month of severance, so I couldn't claim UC in May. In June, I was able to do some online sleuthing to figure it out for a few applications out of the dozens I was making in a week, but there were some weeks I wasn't able to scrounge together even 4. I ended up with 2 UC checks for a total of $756 gross (yes, had to pay taxes on it). I don't remember exactly how much, but I do remember I calculated it was less than 20% my original take home pay for a month.
Luckily, by the end of June I had a good line on a job and started in July. I got lucky that we could bridge a month of basically "no" income from me. I can't imagine what it would be like for a single-income family living here in one of the most expensive areas of the country.
That's a big problem for US based tech companies
It sounds like they're just taxing you less, not paying you anything.
>These costs have to be capitalized and amortized over 5 years – or 15 if labor is done outside of the US.
I’m not an accountant so maybe I’m reading that wrong, but if so that’s insane.
You essentially pay taxes now on income, and can’t deduct costs for 5 or 15 years. So it’s kind of like pre-paying taxes and not getting the money back for 5/15 years. Say that you need to go borrow cash to cover the shortfall. Is it cheaper to borrow money for 5 or 15 years?
If my business makes 400k/year, but I pay a contractor 100k during that year, my effective income is reduced by 100k.
The recent changes mean you can still do that for most staff EXCEPT developers, even if the devs are doing operational work instead of work that feels more conventionally like R&D. So you have to come up with a bundle of cash now to pay tax on most of the developers’ salaries, even though they’ll give it back to you over 5-15 years.
Essentially you making a free loan to the government for a decade or whatever, except the money’s probably not free to you.
Of course I can think of situations where the development effort really was more R&D than operational, and the revenue stream matched: the first few years operated at a loss already, and the deductions might have more been useful in 5 years when the revenues were flowing in from a mature product. But I think they might have ways to carry forward losses to future tax years or something to deal with situations like that?
Because it is an expense maybe?
* Total Revenue: $1,000,000
* Cost of food: -$200,000
* Employee Salary: -$600,000
* (potential profit): $200,000
Assuming you can deduct the cost of food and employee salary to sling your burgers.. you make a 200k profit, and pay taxes on 200k.
But now let's say you can't deduct employee salary. You now pay taxes on $800,000 of income despite only having $200,000 of income. Depending on tax rates etc. you might end up with $0 in your pocket, despite having a successful business.
Now replace McDonalds with bootstrapped startup, food cost with AWS bill, and keep employee cost. This is the real situation many small SaaS or other software companies are currently in.
You can see how if this was 5 years, then I could deduct 1/5 and I would be taxed on $120k profit, which is still bad, but not nearly as bad.
The easy example is a car company, like Ford. If they buy a car factory, that is a capital asset, and the cost needs to be amortized over x years. If they decide to instead BUILD a car factory...they still end up with a capital asset, and the costs (including wages) need to be amortized over x years.
In most cases this is what companies want - they'll have revenues over x years and matching costs over x years is generally better for everyone.
E.g. if you pay $150K for local research, you expense $15K (10%) the first year (and 30K the subsequent year). You pay taxes on $135K of 'profit'. Let's say that's $45K (I have no idea what's realistic here.
Alternately you pay $130K for a dev from Canada, expense $4,333 (1/30) the first year, and pay tax on the remaining 'profit' of $125,666. Even after admin costs you're coming out ahead
This way, all the R&D expenses are happening in Canada.
My feeling is that an EoR (employer of record) like remote.com might be enough for everyone to be able to avoid R&D capitalization. The research happens in Canada, by a Canadian employee of a Canadian company. You pay an American company for outsourcing human resources. The American company pays the Canadian company for human resources services.
Then again, if you're paying another company for outsourced human resouces, but you have an IP assignment clause as part of that, maybe you would need to claim it as your R&D expense
The government has been funding itself instead with “continuing resolutions” which pretty much just continue spending as the prior year modulo marginal changes. Incidentally this is why federal deficits have exploded since 2010: the financial crisis “one time” trillion dollar stimulus has been continued every year since.
The last time Congress passed a budget was for last fiscal year (FY 2023):
https://www.congress.gov/bill/117th-congress/house-bill/2617
It was about three months late, but they passed it. This year's is currently at least about four months late, and the federal government is currently operating under a continuing resolution that will expire in March. However, full-year continuing resolutions are rare: the budget bills are usually passed, but passed late.
Change your employees job titles and/or tax classifications if you have to. Whatever it takes to say "these are salaries, not R&D".
If you're big enough they'll notice, but for a 10-person company the risk of a bad audit beats certain bankruptcy.
I assume this will be the same in the US, software R&D is now some other title with less taxes. When the small companies do it the IRS isn’t going to care but then big ones will do it and the tax law cat and mouse game will continue.
(Note: not recommending to do that, but guessing that is a natural byproduct of an unfair tax code).
Now though I happen to think accelerating it is a good idea, everybody thinks their particular loophole is a good idea. To say that removing the special treatment is a policy mistake is a reasonable position to take, though opponents have a reasonable position as well (as I said I'm in favor of the special benefit). But to call this change unfair is, IMHO, unreasonable.
It's also bogus to plead ignorance as the twitter poster did: "as they'd never had to amortize software development before, and didn't think of the work they do as R&D." Their accountants sure did, because otherwise it would not have qualified for the R&D exemption. And their accountant would have to tell them what to do to make it qualify.
Congress knows this: the law was passed in 2017 but only took effect for tax year 2022. This very issue was widely discussed at the time.
That was five years to figure out what to do and your CFO (or at the very least your tax accountant) should have been warning you. I mean, if your tax accountant doesn't know the tax law that's a bad thing.
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.
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...
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...
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)
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.
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.
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.
It’s interesting that HN is more concerned about the rules changes than the person filing our company’s taxes (or our CFO). This is a topic that is basically glossed over as a non-event between us and those professionals.
(Unlike the wayfair ruling which sent everyone, including our accountants, up in arms about sales tax and how to decide nexus)
Maybe I have a bad accountant and CFO? Or HN is extrapolating this to mean more than it does.
You are the one who originally asked why engineers can't be considered a cost center. There is a reason; the R&D tax credit.
> Maybe I have a bad accountant and CFO? Or HN is extrapolating this to mean more than it does.
I am guessing you just do not qualify for the R&D tax credit or it just not worth the paperwork at your scale. For larger companies (and profitable, fast-growing startups that do a lot of the 'develop' part of R&D, which are rare these days, I guess) there is a benefit.
https://taxfoundation.org/research/all/federal/research-and-...
Considering even the tax foundation claims would bring in less than 20k jobs, maybe Congress made the right decision to bring in amortization even if I disagree with what it funds. I do not have numbers for how much it brings it to the federal government but the credit was already known for being difficult for small businesses to use.
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.
What's more absurd than life itself is that you can deduct 100% of a 6000GVWR truck which you financed for 7 years, but my engineers salaries aren't deductible because I'm "building some product" so that's "development".
I mean give me a freaking break.
Major materials innovations are discovered here, but the only nations that want to actually invest and build upon them are currently in Asia.
The argument was that the US wants to transition away from building things towards building software which is more profitable, and then this...
This is what happens when a monoculture of business/law/finance-thinking takes over political leadership.
The problem with section 174 is not that it disincentivizes R&D. These rules were already in place for R&D spending, and were generally welcomed by companies with actual R&D expenditures.
The problem with section 174 is that it essentially forces ALL expenditure on software development to be treated like R&D.
Update: Now thinking about it, it doesn't matter if an employee leaves, since the company will expense their salary portions that they haven't expensed yet in their future tax bills.
It will set different incentives wiring wise and I’m not convinced they are good ones, but from this rule some people will benefit so they might fight the rollback.
> Given that this also greatly punishes outsourcing
Anyone help me understand these more? My understanding was that instead of deducting the costs of paying software devs the year it happened, it will be spread over 5 years. Which leads to a bigger tax bill now, and benefits bigger companies with deeper pockets as opposed to smaller businesses which have to raise moneny to pay taxes (or lower costs, potentially lower hiring). This should also push companies towards outsourcing, since not all places have similar laws? Is my understanding wrong?
What the (possibly temporary) temporary law probably actually does is decrease the incentive to become profitable for the next couple of years (assuming your business is strong and you can raise another round)
Section 174 removed in new Senate tax agreement - https://news.ycombinator.com/item?id=39013863 - Jan 2024 (3 comments)
Ask HN: IRS section 174 – cause of layoffs? - https://news.ycombinator.com/item?id=38957651 - Jan 2024 (21 comments)
Will US companies hire fewer engineers due to Section 174? - https://news.ycombinator.com/item?id=38931860 - Jan 2024 (38 comments)
Will US companies hire fewer engineers due to Section 174? - https://news.ycombinator.com/item?id=38870429 - Jan 2024 (19 comments)
IRS tax code change in Section 174: R&D is an expense - https://news.ycombinator.com/item?id=38642461 - Dec 2023 (23 comments)
Guidance on Amortization of Research or Exp. Expenditures Under Section 174 [pdf] - https://news.ycombinator.com/item?id=38637540 - Dec 2023 (2 comments)
Tell HN: People laid off in my company due to IRS Section 174 changes - https://news.ycombinator.com/item?id=38633668 - Dec 2023 (6 comments)
Tell HN: Submit comments to IRS re tax treatment of software dev expenses - https://news.ycombinator.com/item?id=38120388 - Nov 2023 (227 comments)
Tell HN: New IRS guidance on software development for Section 174 amortization - https://news.ycombinator.com/item?id=37494601 - Sept 2023 (3 comments)
Software firms across US facing tax bills that threaten survival - https://news.ycombinator.com/item?id=35614313 - April 2023 (985 comments)
Ask HN: How are you handling Section 174 changes for bootstrapped companies? - https://news.ycombinator.com/item?id=34627712 - Feb 2023 (187 comments)
This seems a tad overblown? "brave", "free intel"? Why would we need to hear the same thing from thousands of small businesses? This stuff is all over the industry, but employees are oblivious unless their company is explicitly interviewed?
It's a bad law, but I'm not sure what is interesting about this Tweet.
That's how lawmakers prioritize work.
It seems some kind of lobbying organization for early stage companies might be needed - maybe some think tank funded by a couple early stage focused VCs
Disclaimer: I'm retired, so I don't have a dog in this race.
I pay attention to news coverage and interviews of my company execs, whatever they’re talking about. I don’t pay attention to all other company execs talking about tax law.
1. Global Talent and Diverse Perspectives: DAOs and open-source projects, by their nature, often operate without geographical boundaries. This allows them to hire and collaborate with talent from all over the world, bringing in diverse perspectives and expertise that can be crucial for R&D and innovation. The traditional model of keeping all operations within a single country might limit access to this global talent pool.
2. Decentralization as a Strength: Decentralized structures can offer resilience and flexibility. In a world where geopolitical tensions and conflicts can disrupt traditional business operations, a decentralized model, with no single point of failure or control, might actually reduce certain risks. Intellectual property, in this case, isn't concentrated in one jurisdiction but is part of a global network, which could mitigate the risk of loss due to regional conflicts or regulatory changes.
3. Innovation and Experimentation: The open-source and DAO model is fundamentally about experimentation and pushing the boundaries of what's possible in technology and organizational structures. By embracing these models, companies can participate in cutting-edge developments and explore new ways of working that might not be possible within the confines of traditional corporate structures.
4. Intellectual Property Considerations: While there are legitimate concerns about IP protection, decentralized and open-source models often operate on a different paradigm regarding IP. The focus is less on ownership and more on collaboration, community, and building upon shared knowledge. In many cases, the value generated isn't from the IP itself but from the community and ecosystem that develops around it.
5. Regulatory and Tax Implications: It's important to acknowledge that regulatory and tax environments are significant considerations. However, for some organizations, the benefits of global collaboration and access to decentralized structures might outweigh the simplicity of operating within a single jurisdiction.
example/ Optimism $100 Million for Developers - Announcing RetroPGF Round 3 Recipients https://optimism.mirror.xyz/37Bgum6MfTJWDuE41CH9RXSH5KBm_RCL...
With an S Corp, you have to pay yourself a salary, and if your work is primarily software development, Section 174 might hit you. (IANAL or accountant. Talk to one of them.)
It also applies to e.g. saas used for software development, which never would be depreciated over time previously. So your paid GitHub account? Amortize it over 5 years.
https://www.theregister.com/2024/01/12/us_tax_research/
This change was actually part of the Trump tax cuts in 2017. It was delayed by five years as an accounting trick to make the bill look better at the time: the tax cuts’ projected long-term impact on the deficit didn’t look quite so bad when they tacked on a bunch of tax increases that would take effect in the distant future of 2022 (and with the assumption that this could of course be repealed if Republicans stayed in power).
Why target software companies? I guess because their owners look more like Democratic voters than, say, real estate investors who benefit from massive tax breaks that remain untouchable.
So why just software and not all fields that produce durable intellectual property?
Lets pass that law and see how Disney feels about Founders' Copyright. :D
Also it made me think about the converse, which might be interesting - libre software. Assuming a company has no plans of dual-licensing, ownership of the actual copyright of libre software is independent of how that software gets used to generate income. Anyone else could come along and use a copy of the software to create a business without any license payments to the owner. Or alternatively the original company could donate said software to a nonprofit steward (eg FSF or Apache) and be in a similar position. So accounting wise, it would seem that amounts spent on developing libre software could be more appropriately classified along with things like recruiting, advertising expenses, or even charitable donations, rather than the creation of an income-producing asset.
Setting up that software to work on the company's production infrastructure would still be a development expense requiring amortization. But the work to keep it running would still be maintenance.
There are options and advantages to operating outside the US. US timezone, a USD economy and a territorial tax system makes it easy to operate from my home country.
interview on this topic: https://www.youtube.com/watch?v=BzUAJzKb8bA
In many cases for bootstrap ones it makes them not financially viable - 100%+ effective tax rate would do that if you optimize for early profitability.
Even for VC backed ones, those taxes just eat into your runway. I know a bunch of companies that opt for some weird international setup to try and avoid the effects but it’s really not what you should do in early days…
This is regardless of whether you classify the costs as R&D for the purpose of claiming a tax credit under Section 163.
I don't see anywhere saying that _any and all software development_ is considered "research or experimental". Ie., if some company pays you to build a piece of software and you hand it over when you're done, you were not engaged in research/experimental expenditures if you paid people to build said software.
Then it's your customer's R&D, and they have to amortize their payment to you. If you're doing outsourced software development for SMBs and startups, you might not be directly taxed under this rule, but your customers are, which significantly affects the market for your services.
> 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.
> (a)In general > In the case of a taxpayer’s specified research or experimental expenditures for any taxable year—
So if you are not doing "research or experimental expenditures", all of the specifications in this section do not apply to you.
But I thought the "useful life" of software was 3 years. No?
Anyway, even that 3 years common knowledge number is biased into long-lived code. Do you spend work time putting out fires? Do you write code that is immediately discovered to be wrong so you have to take more time and fix it? Those 3 years are only for software that already passed through all of that.
(Anyway, I don't have any interest on that fight, I'm just watching from a safe distance.)
I don't have a dog in this fight either. Does "maintenance" on an amortized asset have to be amortized as well? Don't know.
Usually not. Also, from other comments here, it looks like bug-fixing doesn't count as R&D (anyway, in a development focused company, you'll probably spend more deciding what is or isn't bug-fixing than you'd get from the difference).
Still, there are many more things that make software disappear just after being written. It's actually similar to most of R&D, so it makes little sense to count it the same way as capital investment.
Wish us luck, because we’re going to need it.
[1] https://www2.deloitte.com/content/dam/Deloitte/us/Documents/...
If a programmer is building an app that isn't yet offered as a product, is that R&D?
If a programmer is maintaining an app that is offered as a product, is that NOT R&D?
It was always a sham. We were building product.
[0] This is based on working at a company that went through a brief period where we had to do extra tracking to be able to capitalize our time if it was possible, and then reading up on the matter to try and understand what the hell the purpose was. Possible I'm wrong about the matter--I've never been the one doing the finances.
The term generally includes all such costs incident to the development or improvement of a product.
What has changed is section 174 - previously all software development could be expensed (without any justification needed) and now it must be capitalized.
Bug fixing, for example, is not covered by Section 174.
tldr: if they're developing new features, it has to be capitalized; if they're doing maintenance then it can be immediately expensed
However I doubt they'd leave such an obvious loophole. Surely the IRS's definition of R&D includes all types of software development activity.
I literally just linked to the IRS' definition that says not all software development activity is included.
The gray zone comes when a bug fix actually provides a new feature (e.g. something that wasn't actually usable before).
(As far as I can read it, if passed it would delay this until 2025, likely with the intent to change the laws before that but with more time to debate.)
Granted any sizable org won’t be, but Joe’s SaaS or Alice’s App is likely operating on a cash basis with a standard Jan/Dec fiscal year.
Republicans have been talking about shrinking the size of the federal government for decades. They routinely fail to come up with substantive cuts in spending that would not set off a disaster for them at the polls, or for the country economically, or both.
There is this perception that the federal is full of wasteful spending, but this perception is false (there is waste, it's not a large percentage of the huge overall federal budget). This means that to actually cut the revenue needed will require truly substantive cuts to the services provided and performed by the federal government.
Maybe you could be more successful at proposing what those cuts would be than any Republican has for 50 years, but it seems unlikely.
While there are certainly people who believe as you do, you are not in a majority. There are also a lot of people in Argentina (possibly a majority) who don't agree with those policies either.
As a different entity type, if you pay yourself a salary, I believe you amortize that like any other company would. But if the U.S. is anything like Canada, you can pay yourself a much lower salary, and then pay yourself through dividends as well.
Then why not provide some links, it isn't secret then?
Why wouldn't people be able to talk about it.
What is brave about discussing a tax policy? There was not context given about what it is, what is is causing.
> In 2017, then-President, Donald Trump, signed the 2017 Tax Cuts & Jobs act, which overhauled tax codes and reduced tax – for example, it reduced the top tax bracket from 39.6% to 37%. To make the bill pass strict budgetary rules, the Senate used a process called reconciliation: adding in tax code changes that delayed tax increases. These delayed increases “balanced out” the tax reduction.
You’re over simplifying and singling out your pet political issue in an effort to sway opinion to your political leaning. If you had just said it was due to those tax cuts you likely wouldn’t have been downvoted.
https://www.taxpolicycenter.org/publications/distributional-...
[0] https://taxfoundation.org/data/all/federal/summary-latest-fe...
Everyone, call your Reps and ask them to tell leadership to support the tax deal!
Or- sure we launched the platform and that was R&D but now we're just doing data entry.
https://www.irs.gov/pub/irs-drop/n-23-63.pdf
is extremely clear on this. New features, improvements? All costs must be amortized. You can only expense bug fixes and GUI changes that don't add features.
Let's just say I started a company last year. I sell software and made $100k revenue this year. I hired someone for $100k to help build that software. I have zero dollars left in the bank at the end of the year.
According to 174 I can only amortize that $100k over 5 years, not all at once. So now I have to pay taxes on $80k profit. I have no money in my bank account, how can I pay any taxes at all?
It's not like I'm going to fire my engineer, he does feature and maintenance work. Let's say that next year my business stays the same. 100k in 100k out. I still have no money in the bank and have to pay taxes on $80k profit, again?
What??
Every little startup in Silicon Valley makes software, spends a lot on salaries, and is barely breakeven. How... am I expected to run a business like this?
You can only deduct 10% the first year. Every year after is 20%, then year 6 is a "make up" of the last 10%.
So year 1 would be $90k now not $80k.
> Because of the tax code’s accounting conventions, domestic firms ultimately have to deduct 10 percent of costs in year one, 20 percent of costs each year in years two through five, and the remaining 10 percent of costs in year six.
What? Why is all software work counted this way? Why software? Shouldn't I be paying taxes later once I've made money? This is like paying taxes on unrealized gains - I can't pay those taxes - I haven't made any gains!
Then Congress did not roll it back. So here we are.
This is absolutely about taxes being charged against non-existent profit.
That “income” is being legislated into existence by disallowing the deduction of customary primary operating costs that are allowed in any other business.
In effect, it becomes a tax on revenue in the early years of a software company. Taxes tied to revenue are notorious for creating unhealthy and perverse market incentives, which is why very few jurisdictions use them. Many small software businesses are now in the position of potentially literally paying more income tax to the IRS than the profit + asset value over the entire life of the business. It is pretty messed up to make small business owners pay “income” taxes out of their own pocket in the absence of offsetting profit.
It is yet another indefensible and unique perversion of reasonable policy under US tax authority.
If it’s not classified as R&D then you just treat it as a normal expense and you aren’t impacted by this rule.
Am I reading this incorrectly?
Maybe if Silicon Valley wasn't so intensely ideological it would have backed the right horse when it came to tax policy. I have very little sympathy here because I think most software developer salaries really are 'development', the problem isn't the classification of developer salaries, it's that the current corporation tax is dumb.
Section 174 is a hack to fix a moronic tax that would have been replaced if not for the left. There shouldn't be a section 174 to even amend. And as I said, software development clearly is development, the change makes perfect sense.
If you want R&D to be taxed (even with deductions which get amortized), and you work in R&D, you don't get to whinge when a loophole gets closed so you get taxed like other R&D expenses. The people getting bankrupted by this deserve it insofar as they opposed the tax reform bill that would have elegantly solved this problem forever.
For instance, imagine a competition over the AI toaster market. You have Philburn, the broke PhD student with a great idea, Burnright LLC, the toaster algorithm and electronics designer, BurnCo, the manufacture, and B2N, the toast technology venture capitalist.
A few scenarios: 1) BurnCo hires Philburn for internal R&D. 2) Burnright develops the tech and licenses to BurnCo. 3) BurnCo contracts Burnright for R&D. 4) Philburn starts Smoke, gets B2N investment, and gets acquired by BurnCo.
Which of these, or others, become comparatively advantaged with this new tax treatment?
Foreign-run software companies not affected by this law, big companies with deep pockets that don't need to fear upstart competition, and other industries that are not R&E but can enjoy the lower tax rates from TCJA that were paid for with this revenue.
It seems that the number of software engineers involved in actual R&D (according to my admittedly made up and subjective definition) is vanishingly small, much less than 1% in all likelihood if we do some quick napkin guestimates.
So to what extent do we want to provide tax incentives to (an already profitable in some cases but also commonly accused of setting big piles of money on fire) industry for normal run of the mill product development? That's what's really going on here imo, and it's not obvious to me that there is any way to justify that. There has to be some line drawn somewhere between applications development / product development, and true R&D ala some systems research group working on scheduling algorithms or whatever.
I admit that the line here is blurry and not well defined. That needs to change if there are tax incentives involved.
At the very least, anything that you know for sure is going to end up in an end product is NOT R&D. The definition ought to depend on what a reasonable and informed observer would classify the risk of total failure to be. True R&D tends to have a very high risk of complete failure in either a technical sense or a product integration sense (as in, you find a solution to your question but it cannot be made into a commercially viable product, often for technical reasons or the specifics of your solution). That is what laws like this are intended to incentive, because we have collectively decided that we want this research to take place even if the risk calculus is such that it is entirely unprofitable for a lot of companies.
There are two possible arguments here to try, and I have only ever seen people lobbying against this change use the one, less persuasive argument. That argument is what I will call the "incentives" argument: that change in the rule provides bad incentives against doing R&D. This argument goes along the lines of "this will cost jobs for R&D workers" or "this will reduce the competitiveness of the US." The other possible argument (that I have not seen cited) is that "R&D" work can be operational, and that forcing capitalization of R&D expenses is a bad accounting practice. This Twitter thread only argues the former.
The glaring problem with the incentives argument is that it gives up the point that the ability to operationalize R&D work is a subsidy for technology and software companies. This is equivalent to asking for a subsidy at a time when startups can pull $100 million with no product and other technology companies are reaping record profits. That is not a particularly persuasive argument, and it triggers bad emotional reactions from people. If not for the SBIR companies getting absolutely shafted, the responses to this argument I have seen from non-tech people range from "fuck you" to "deal with it."
The accounting argument is boring and sort of technical, but also a lot harder to argue against and doesn't trigger a negative emotional reaction. All of the people making the rules will understand it, and the IRS could even make the clarification on what is and isn't "R&D" on an accounting basis without an act of congress. They have kind of done this, but have not been pushed nearly far enough.
Two factors also don't help matters either:
* Most people, which perhaps surprisingly includes most commenters here, don't understand what taxes are levied against or what losses and amortization even are. You can't effectively argue against something you don't understand.
* Of the people who do understand taxes and income/loss sheets, it's only the business owners and accountants who like putting as big a number as possible under losses to reduce net profit and thus taxes owed. The commons rightfully see it as tax avoidance, which unsurprisingly is met with "fuck you".
AKA: "How dare people want to keep their own money and not freely give up larger and larger percentages to ever larger government programs that are inefficient cesspools of mismanagement and corruption".
I'll match people saying "fuck you for wanting to keep your own money" with a fuck you for supporting the destruction of businesses on the notion that it's the governments money in the first place.
I don't know enough accounting to figure it out for myself.
After all, the IRS doesn't use GAAP.
What I haven't figured out is what the Dev agency has to do. They don't own the software being developed. Unless they have in-house libraries they develop...
And how does this work for open source projects that have corporate support to be developed on during company time? If you amortized the "R&D excited" of the developer's salary on the premise that the software will make long-term, recurring income, what does that mean for software that isn't being sold?
My previous job, I was the only software developer, making a tool that employees and customers in the company used together. We didn't sell the software, we sold a service completely unrelated to the software, the software was just a supplement to the service.
Does a developer keep doing work for me after he quits/dies?
I think that might have a lot of unintended side-effects.
I have yet to see any other case of salaries being turned into Capital Expenses (aka something that requires amortization/depreciation). I'd understand if outsourcing (or otherwise contract work) would be treated as something to be amortized, but we're talking SALARIES.
> Changes to R&D amortization were a rude surprise to them, as they'd never had to amortize software development before, and didn't think of the work they do as R&D.
Precisely. They didn’t think of their work as R&D because it was not R&D. Frankly, they should have seen this coming.
> These are small businesses we're talking about. Almost all of them make under $10M in annual revenue, and the vast majority are under $2M in revenue.
What about the millions of other small businesses that don’t get special tax treatment? Restaurants, bars, plumbing companies, landscaping companies, accounting firms, etc.? Software engineers are not scientists. At the end of the day, a company is supposed to be able to stand on its own two feet, not rely on government handouts. Allowing otherwise unprofitable businesses to stay in business disincentivizes innovation and efficiency, which harms productivity growth and makes us all poorer in the long run.
If you run a plumbing company, make $100K in revenue, pay a plumber $100K, you have no profits, owe no corporate taxes.
If you run a software company, make $100K in revenue, pay a software engineer $100K, section 174, which just went into effect recently, means you now owe taxes on $90K of profit. This is because you must spread dev costs over 5 years, you can’t deduct them in the year they happened.
Don't you have this backwards, or do I?
Software development is now going to be treated as R&D, which means that costs have to be amortized. That's not an tax advantage, it's a disadvantage. All the other businesses you list get to expense their labour costs. But we agree, software dev should not be treated differently.
I wonder how this one will pan out.
Let's say you build out a landing page with a way for folks to input their email address which demonstrates interest in your product. You've released it and people can sign up.
Did it launch? You could make case it did and now you're iterating on the product from here on out. You've launched phase 1 of the product which is probing for demand.
Any software development costs related to improving the product by providing new features must be amortized. Only clear bug fixes can have costs that are expensable.
This is made extremely clear in the IRS guidance document.
>Research and development is the set of innovative activities undertaken by corporations or governments in developing new services or products, and improving existing ones.
>R&D activities differ from institution to institution, with two primary models of an R&D department either staffed by engineers and tasked with directly developing new products, or staffed with industrial scientists and tasked with applied research in scientific or technological fields, which may facilitate future product development. R&D differs from the vast majority of corporate activities in that it is not intended to yield immediate profit, and generally carries greater risk and an uncertain return on investment.
and as you see "R&D department either staffed by engineers and tasked with directly developing new products, or staffed with industrial scientists and tasked with applied research in scientific or technological fields, which may facilitate future product development"
developing new products falls under R&D
Why? There's a clear relationship between R&D spend and economic growth. This is including R&D spend on non-scientific endeavours like commercial products + processes, which the majority of non-maintenance software work falls into.
Estimates vary, but I've never seen a cost/benefit analysis of unrestricted R&D that finds anything lower than a $2 return for every $1 spent in unrestricted R&D.
> The whole thing backwards, he gets.
Not too surprising, I guess.
Have you forgotten the D in R&D? Software engineers are building the product. That’s development.
What do you mean by “genuine scientific research”? I suppose you think ML researchers aren’t doing “genuine science” because they wear hoodies instead of lab coats?
My programmers build software.
Should builders building a house amortise their development work?
Though, the country where I work and live, R&D has more profitable tax treatment, your employee costs are a same year expense, but you can get some relief on the rest if your tax bill if you proactively document what's R&D about your work and it doesn't get rejected by the tax department
I get the point but software really is different. Rarely ever are you building the same thing over, both from a “structural” or “architectural” perspective and from a functional perspective.
If your builders are creating a brand new blueprint for every house /structure and designing everything from scratch then I think it’s more similar, probably closer to commercial property builders with large structures.
Now under that perspective, I still don’t exactly understand why you’d treat labor cost deductions differently. Maybe the fact that these more complex products and services being built have higher return potential? I don’t know, I’m searching for a rational reason.
But, I do disagree treating software like something as commodified as many forms of labor. Someday we may get to that point with simple principles and procedures to follow, albeit technically, but we’re not there yet. At higher levels that may not be much “research” that’s needed but where the rubber meets the road, your engineers are checking to see what exists and doesn’t, designing new solutions to fill gaps in between, testing things, digging into previous things that don’t work and trying to fix them… it’s research.
As we continue to move more professions to an intellectual economy, many roles are becoming more and more like this, not just software. I’d say loading more roles and expectations on labor is also creating this situation where we’re asking more people to do more things they don’t know or can’t possibly know everything at a proficient level and the things we’re asking them to do don’t have solutions that can be written down and quickly referenced when needed as a simple recipe to follow. If you make the recipe general enough (e.g if a problem arises, find a solution and fix it at a low cost) then one might point to such highly generalized solutions and pretend it’s a solved problem but it’s not, it lacks any useful concretization. “You're not doing research, I told you ‘if a problem arises fix it’! There’s nothing to research you just do that!” doesn’t cut the muster.
That's not the case if you contract your builders out to build a house for someone else and they pay you for the hours, but IMHO it's also not the case (even with the new changes) for software developers being 'rented' as contractors to build stuff for others and the company getting paid for their hours.
I don't have a fully formed opinion on this aspect of the taxation, but it's pretty evident that this is out of the norm.
Do any of those businesses owe taxes before they've collected their first cent of revenue? That is the situation a software startup is now looking at.
Software is now in the unique position of being required to pay taxes on revenue instead of profit. If you spent $5M on development and raked in $100k, you'll be taxed on $100k (minus expenses, where the $5M must now be spread over 5 years). Of course, with those numbers, the company might want to spread costs over 5 years anyway (which they could already do).
So really, it's as if the tax code is specifically targeting bootstrapped companies that are reinvesting their profits back into the company. IMHO, the worst possible option of any that could have been chosen to milk software companies. Large established companies can afford it, VC companies were going to amortize anyway.
Yeah, you "eventually" can expense your costs. But that just means that it's a tax grab on the smaller companies that will be put out of business by this move. They pay all the tax this year, go out of business, and never get to reap the profit of the development work.