Small Businesses Face Big Tax Bills from Research-Deduction Change

https://www.wsj.com/articles/small-businesses-face-big-tax-bills-from-research-deduction-change-a189b113

by hosh • 3 years ago

4 6 3 years ago

hosh2• 3 years ago

This affects technology companies, particularly startups. There is an specific provision which considers software development as R&E, and all software development must now be capitalized. It will create a chilling effect on software development within the US.

From a different article:

The TCJA also specifically added software development to the definition of R&E expenditures under Section 174. As a result, all software development costs must now be capitalized as well, regardless of whether the software is intended for internal or external use.

https://www.claconnect.com/en/resources/articles/2023/a-cost...

verdverm2• 3 years ago

That link is very misleading, salaries are tax deductible. No way those numbers make any sense in reality.

hosh2• 3 years ago

That is not what I am hearing from tax people and some folks I know running software agencies. I posted this here because it seems to be coming in from the blindside for the HN crowd.

This is still up in the air, but the growing consensus among tax experts seems to be that, while payroll may be expensed, the percentage of that payroll used for R&E, including software development, would have to be amortized as capital.

Here is a different article. It calls out just how vague this is, since there is no specific definition of what “software development costs” are:

https://www.thetaxadviser.com/issues/2022/jul/legislative-ch...

From this article:

Taxpayers must resolve a number of technical issues that currently are not addressed in regulations or other IRS and Treasury guidance, including:

- The definition or scope of R&E activities;

- How software development costs are defined (e.g., whether they include installation of acquired software);

- Whether Sec. 174 is an activity-based test, ownership-based test, or both;

- Whether Sec. 174 requires the taxpayer to be at risk for the development;

- Whether a contractor performing R&E services for a client has Sec. 174 expenditures where the contractor is not at risk and has no ownership rights in the resulting intellectual property;

- The extent to which overhead costs are considered Sec. 174 expenditures; and How domestic and foreign research activities are distinguished from one another for purposes of determining whether the costs are amortized over five or 15 years.

gamblor956• 3 years ago

No, the primary outcome will be the proper bifurcation of software programming between programming (currently expensed) and engineering (capitalized).

For example, identifying what to do (program features) and how to do them (program structure) is R&D work. Test development is also R&D work (since the development of QA processes is considered R&D, even though the QA activity itself usually is not).

Coding software to spec based on known outcomes, structures and/or tests is not R&D. It's just coding. It should never have been treated as R&D, and doing so was always an aggressive tax position to take; while common in SV and Fortune 500 companies, on the whole it is actually uncommon for most companies to treat software programming as R&D.

And it's not even all that devastating for SV as an industry, since you have to have profits for this tax change to matter, and profits aren't something that SV companies are known for. Meanwhile, since most companies never treated in-house software programming as R&D, they're unaffected by this change, and this is demonstrated by the tax industry's lackadaisical response to this change since most of their clients aren't impacted.

maf2020• 3 years ago

It’s clear from the responses to your post that most of your fellow software developers are in a state of denial. I can appreciate their position. I couldn’t believe our government representatives could be this insane, either. But, apparently, they are. I wish that they were right. I’d be very happy to be wrong. But all the information out seems to suggest otherwise. Just as a small sample, this is from E&Y. No small accounting firm, they:

“The modifications made to Section 174 include a new subsection that specifically includes any amount paid or incurred in connection with software development as a research or experimental expenditure (and, therefore, within the scope of the provision). Presently, these costs may be deducted or amortized under Revenue Procedure 2000-50. Once the new Section 174 provisions take effect after 2021, Revenue Procedure 2000-50 will no longer apply to any software development costs, and they will be subject to the required amortization under Section 174. As a general rule, purchased software may be amortized over 36 months under Section 167(f)(1). This means that, under the Act, taxpayers developing software will be in a less favorable tax position than those acquiring it.”

There’s no way around it. This is an existential threat to technology companies in general and software companies specifically.

Small Businesses Face Big Tax Bills from Research-Deduction Change

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