[HN Gopher] Tell HN: Submit comments to IRS re tax treatment of ...
___________________________________________________________________
Tell HN: Submit comments to IRS re tax treatment of software dev
expenses
Public comments can be submitted regarding IRS Notice 2023-63
"Guidance on Amortization of Specified Research or Experimental
Expenditures under Section 174," here:
https://www.regulations.gov/document/IRS-2023-0040-0003/comm...
The guidance in question can be found here:
https://www.irs.gov/pub/irs-drop/n-23-63.pdf There was previous
discussion of these rules on HN here:
https://news.ycombinator.com/item?id=35614313 To very briefly
summarize, these rules force certain research expenses to be
treated under Section 174 and thus capitalized and amortized over a
period of 5 years, instead of under Section 162 (ordinary and
necessary business expenses) which are immediately deducted in the
year they occur. Part of the issue is the extremely broad
classification of "research expenses". Notably, it classifies
virtually all software development as research, as well as the
proportional share of all overhead/fringe expenses. It also changes
the treatment of contracted research activities (note that includes
software). This has a hugely negative impact for early-stage
startups, contract research firms (i.e. SBIR companies), and
independent software developers. To construct a basic example:
Revenue: $100k Expenses: $100k (developer salaries)
Net operating income: $0 Taxable income: $100k - 0.1x100k =
$90k (first year deduction is 10% of SREs) Come tax time, you
now owe the government $18-30k taxes on your $0 real income.
Author : mNovak
Score : 262 points
Date : 2023-11-02 21:26 UTC (2 days ago)
| tldrthelaw wrote:
| I wrote about it here: https://news.bloombergtax.com/tax-
| insights-and-commentary/ne...
|
| Please do submit comments.
| Kon-Peki wrote:
| I had forgotten about this, it's hard to believe that it still
| hasn't been fixed.
|
| I've read through a number of the comments, and I guess I
| shouldn't be too surprised to see that most are asking the IRS to
| do the job of the US Congress. This fills me with despair.
| hn_throwaway_99 wrote:
| That's the problem with basically the entire federal government
| these days. The US Congress is as near to non-functional as one
| could imagine. This, actual rule-making has been "delegated by
| dysfunction" to other entities like the Supreme Court,
| Executive Orders, and federal agencies.
|
| I really wonder how long this can go on. Our system of checks-
| and-balances only works when rational actors believe that
| compromise is necessary to get things done. When you have
| actors that believe that shutting things down completely is a
| benefit because it gets them more media time and rabid
| followers, the whole thing breaks down. Perhaps at some point
| we'll be able to move more towards a Westminster parliamentary
| model, where the party in power at any particular time
| basically controls both the executive and legislative branches
| simultaneously.
| gustavus wrote:
| > Perhaps at some point we'll be able to move more towards a
| Westminster parliamentary model, where the party in power at
| any particular time basically controls both the executive and
| legislative branches simultaneously
|
| This for me always been one of the most frightening aspects
| of the parliamentary model. There aren't checks and balances,
| instead the party in power, as long as they have enough power
| can rule with absolute authority.
|
| You fail to understand that the US constitution was not
| created to provide for an efficient government it was
| designed to protect individual rights.
|
| The much bigger problem in my mind is that we only have 435
| representatives and so each congressman represents far too
| many people, which allows the loudest and craziest vocies to
| dominate. Instead if we doubled or tripled the size of
| congress we'd have quite a bit more nuance and the government
| would be more representative.
| no_wizard wrote:
| not to mention we semi-divorced (and I think in some cases
| totally divorced) state politics from federal politics when
| we started voting directly for Senators in the other house.
|
| Before that, your governor would choose who the senator was
| via whatever the process the state had for this. It had a
| knockoff effect of people caring a lot more about their
| state and local politics and keeping some governing power
| in the states leadership. Both I sincerely believe were
| worthwhile goals, as many people get caught up in federal
| politics and there is far less population participation in
| state / local politics as a result.
|
| I do believe quite strongly that we need a bigger House of
| Representatives too. I 100% agree on that. I don't think
| the founders foresaw a world with 300 million people living
| in the US
| hn_throwaway_99 wrote:
| > You fail to understand that the US constitution was not
| created to provide for an efficient government it was
| designed to protect individual rights.
|
| Take your BS condescending tone elsewhere. I don't "fail to
| understand" anything. There are plenty of other nations
| with parliamentary systems that protect individual rights
| just fine, arguably much better than the US does.
|
| > There aren't checks and balances, instead the party in
| power, as long as they have enough power can rule with
| absolute authority.
|
| Except, again, plenty of functioning governments with
| parliamentary systems show that if a government
| overreaches, they are still responsible to the will of the
| voters, who can (and do) kick them out at the next
| election. I think it's much better to say "OK party X,
| we'll try your ideas for the next few years, and if you f
| it up you're gone." rather than have nothing get done for
| years, where each side can blame the problems on the other
| for why they couldn't achieve their agenda.
| amanaplanacanal wrote:
| Yes. Notice that of all the nation building the US has
| indulged in over the years, essentially all of it sets up a
| parliamentary model rather than the one the US has. I wonder
| why that is?
| creer wrote:
| Yes! It's horrible the lack of understanding of our most basic
| institutions in this country. It's a fundamental problem. And
| not helped by either education system or the press currently -
| both more interested in punchy headlines.
| jppittma wrote:
| My only hope is that when our republic finally does follow in
| the footsteps of Rome and become an empire that we at least
| have a decent administration.
| hesdeadjim wrote:
| Section 174 hit my company hard, it's such bullshit.
| ezekg wrote:
| Clickable link:
| https://www.regulations.gov/document/IRS-2023-0040-0003/comm...
| tikkun wrote:
| There are 43 comments so far. I was expecting thousands of
| comments.
|
| Comments can be with your name, company name, or anonymous.
|
| There's no required info you need to give other than the comment,
| no account required. Submitting a comment takes 'time to write
| comment + 5 seconds' - it was very easy.
|
| The comments have been open for 58 days, and they close in 20
| days.
|
| Side note: Which of our reps should we call about this, how do we
| find which rep applies to us, and how can we contact them and
| what to say? It'd be nice if someone made something like
| Resistbot for this.
|
| (Though, after checking out the updated version of Resistbot, it
| seems like Resistbot will in fact work for this.
| https://resist.bot)
| mNovak wrote:
| I was also surprised how few comments there are. It has been
| making the rounds in the SBIR community, (you'll see that if
| you read a few public comments) but I saw almost no one
| mentioning the software side of it. I submitted one on behalf
| of my company. Others should too, it's really very easy to do.
| pclmulqdq wrote:
| Total number of comments also doesn't usually matter in these
| government comment periods (or at least not in the way you
| think it does). They are looking for new arguments to support a
| position one way or the other, not 10000 people commenting with
| the same take. If 10000 people say "this rule change is bad
| because my tax bill is higher," that's confirmation that it's a
| revenue driver, not an indication that it's a bad rule.
| jncfhnb wrote:
| What's the argument on making software not being an investment
|
| Aside from "it's bad for my startup"
| joebob42 wrote:
| Very few pieces of software in my experience are doing anything
| 5 years later. 5 years seems like an extremely long time to be
| amortizing over.
| jncfhnb wrote:
| Why?
| cscurmudgeon wrote:
| Because the world changes.
| twodave wrote:
| I think the obvious implication is that software
| development is expensive, ongoing and tends to result in
| relatively short term ROI, and therefore the amortization
| schedule of 5 years increases the likelihood smaller
| business will never collect most of it, while larger
| business that can absorb more up-front costs will be able
| to collect it pretty easily.
| jncfhnb wrote:
| That is not an argument for tax treatment of whether
| something is an asset
| twodave wrote:
| I wasn't trying to make that argument, but I were I would
| argue that software itself is more like a liability, or,
| at the most, a current asset[0]. Source code has no
| inherent value, and in fact the more you have the more
| expensive it is.
|
| [0]
| https://www.investopedia.com/terms/c/currentassets.asp
| jncfhnb wrote:
| That interpretation is deeply removed from how accounting
| works, but even if it were a current asset it would still
| not be an expense
| withinboredom wrote:
| Because most software devs don't stick around long enough
| to write software that can stand the test of time. It
| requires a few things: like don't use libraries unless they
| are well funded (includes frameworks) or have already stood
| the test of time (like bootstrap for the FE or React, etc);
| don't hide logic deep in the code, put logic as high level
| as possible (like in controllers, which is the exact
| opposite of short-lived software; and many other little
| things.
|
| I have several projects running in prod, at several
| companies, for over a decade. They are easy to maintain,
| easy to extend and build on, and easy to understand.
| jncfhnb wrote:
| You can be changing the code every day and it's still the
| same asset yhough
| libraryatnight wrote:
| Removing the financial aspect for a moment, since I'm not
| informed enough to comment, I would like to say lots of
| companies are essentially running on software way older than
| five years and a lot of their employees don't even realize it
| because the 'new' development has mostly been repurposing the
| old software into apis and services that they then consume
| for their new stuff, but that old thing is still down at the
| bottom running the stuff, and the team doesn't understand it
| enough to do more than consume it, and there's always an ugly
| moment when something goes wrong and someone on an incident
| call asks "I thought that was retired?"
|
| And then the devs do the "Well uh, it is, but we still uh,
| consume...uh...apis...endpoints... umm yeah it's not retired.
| Hank the ancient that now does dev finance built what we're
| using, we should get his help" And then hank gets on the
| phone with a sigh and fixes it.
|
| I initially thought this was something exclusive to where
| I've worked, but after some years it seems to be true more
| frequently than I'm comfortable. When it's really bad you
| realize the entire company was built by Hank and maybe one
| other dude who got laid off and everybody else has just been
| making bootstrap wrappers of their tool for 15 years between
| the bare minimum to keep the servers compliant.
|
| When I meet a software engineer that gives me the impression
| they're an engineer and not their clan's webmaster, it's kind
| of a cool day.
| AnthonyMouse wrote:
| But this is also kind of making the opposite point: Hank
| wrote that thing 15 years ago, it wasn't even a large
| proportion of your long-term development expenses, and now
| all the other developers are actually doing maintenance
| work to keep the old code compliant with regulatory changes
| or integrated with external moving targets, none of which
| has long-term value because there will soon be other
| regulatory changes and the moving targets will move again.
| jfk13 wrote:
| True; though for a counterexample, may I introduce you to
| TeX? Over 4 decades, and still in wide use.
|
| Sure, there's been maintenance over the years, one
| significant version update (TeX 3.0 in 1990) and an ever-
| evolving ecosystem around it, but the core engine has been
| incredibly stable.
| fritzo wrote:
| I guess you could say this new tax treatment incentivizes
| writing more stable, longer-lasting software artifacts?
| fdasava wrote:
| If/when software goes out of use, it can be written down and
| deducted immediately. The 5 years is a maximum, not a
| minimum.
| PaulDavisThe1st wrote:
| Every DAW except Bitwig, every non-browser based image
| editing tool, almost every web browser, every OS, half(?) the
| apps in any app store, every IDE I can think of, every text
| editor and word processor and spreadsheet ...
|
| all far, far older than 5 years.
| cma wrote:
| Survivorship bias?
| creer wrote:
| At some point, accounting and the tax code have to recognize
| business reality. It could be an "investment" and taxed in a
| way that makes sense.
|
| The problem is that "at some point" can drag for decades and do
| a lot of damage (ie transform the economy and not in a
| deliberate manner.)
| boredumb wrote:
| Trailing off a week of thinking about the executive order on AI
| research, i'm finding it harder to not think there is an active
| effort to stifle innovation and progress among little folks.
| toomuchtodo wrote:
| Please provide a template for quick customization and submission.
| This will help scale with the remaining time left.
| CoastalCoder wrote:
| Anyone have a sense of how much this has contributed to the past
| year's layoffs?
|
| The _only_ factor I usually hear about is raised interest rates.
| pclmulqdq wrote:
| Most of the arguments from startup people about these rules come
| down to "this change costs me a lot of money" rather than "this
| change is bad accounting." Does anyone know what the arguments
| are to support the latter?
|
| When this rule was changed, it was framed as eliminating a tax
| loophole: R&D work is basically a capital investment, since you
| are effectively buying and improving intellectual property during
| the R&D process. That suggests that this sort of expense really
| is a capex that should be depreciated over the life of the
| intellectual property rather than an opex. I personally think
| that this is a compelling line of reasoning.
|
| I think there's a good argument that a forced 5-year amortization
| schedule is far too long for something like a random SaaS, but
| I'm not sure if I have a good argument that this is bad
| accounting otherwise. I don't expect that the IRS will be all
| that sympathetic to Silicon Valley complaining that one of their
| favorite loopholes is gone otherwise.
| 1123581321 wrote:
| The accounting argument is that not all software development is
| R&D work or creating an asset with long-term value. A lot of it
| is operational work or closely tied to the revenue that pays
| for it (so analogous to COGS.)
|
| There is also an accounting and tax principle that small/solo
| businesses should be able to maintain simpler books that let
| them reliably feed their families year-to-year; an sudden
| upfront tax burden for a solo dev impedes that.
| pclmulqdq wrote:
| As I understand it, under the current rules, you can classify
| maintenance work as an opex. You just can't argue that
| development of new software is an opex.
| DougWebb wrote:
| What kind of software maintenance work does not create new
| software? Are you only deleting lines of code from the
| existing software?
| AnthonyMouse wrote:
| There is also plenty of "R&D" that has only short-term value.
|
| If you make a spam filter, you have to spend resources making
| sure it can defeat the spammers, but the lifetime of your
| countermeasures is often measured in months or weeks rather
| than years.
|
| You may have to pay developers to integrate your product with
| a third party product, but there is a new version of the
| third party product released every year so every year you
| have to do it over again.
|
| > There is also an accounting and tax principle that
| small/solo businesses should be able to maintain simpler
| books that let them reliably feed their families year-to-
| year; an sudden upfront tax burden for a solo dev impedes
| that.
|
| And the correct accounting period to amortize a particular
| expenditure may not be known in advance. If you build a
| product and it has unanticipated flaws that require you to
| start over, the lifetime of the original R&D is trivial. Or
| it could be a success and generate revenue for decades.
|
| The IRS gets their money either way, whether it's now or
| tomorrow, but if in cases of ambiguity they insist on now,
| the disadvantage is primarily to early startups. Large
| corporations with a stable R&D budget will be deducting their
| full R&D expense every year because they'll have R&D expenses
| from five years ago to deduct this year, but anyone just
| starting out won't. That's a poor choice as a matter of
| _policy_.
| mNovak wrote:
| For me personally, the 'bad accounting' comes into play with
| contract work. You build some widget for customer, and if it's
| anything less than work-for-hire (i.e. you give customer a
| commercial license but retain copyright or some right to reuse
| your code in the future), that was research and gets amortized.
| Think like building or just modifying a Bootstrap template --
| is that really "research"?
|
| Maybe it's not concrete, but it feels like there's a difference
| between investing capex into a planned future product, and
| retaining some rights in the work you create for others.
| jtchang wrote:
| I don't think the issue is bad accounting. I think it comes
| down to software being uniquely different than a factory or
| piece of equipment. Amortization schedules that are even don't
| make any sense. Neither does anything measure in years. It's
| because we make improvement to software on a day by day basis.
| We don't necessarily add on to a factory every day.
| krupan wrote:
| "Intellectual property" is a huge misnomer and it should not
| indicate that software development is a "capital" investment.
|
| If you disagree, I'm curious what you think about this: if the
| software you develop is all open source would you still call it
| a capital investment? Maybe it could be classified as a
| charitable contribution?
| pclmulqdq wrote:
| Yes, I would. Open-source doesn't mean "not intellectual
| property." It means "intellectual property open to everyone."
| krupan wrote:
| Lol! What even is property?
| patmcc wrote:
| I think it's bad accounting to treat all software development
| as creating capital assets; some of it clearly is, and should
| be treated as such, although maybe 5 or 15 years is not the
| right amortization schedule for software.
|
| I like to use the factory analogy - if you're Ford, and you
| build a big factory to build cars, that's a capital asset, you
| need to amortize the costs. But the workers inside, making each
| car? Their wages are expenses, tracked against the revenue of
| the cars they make. So - if you make a game engine, that'll be
| used over the next decade or two, that's a capital asset. If
| you make a game, that'll see 95% of its revenue in the first
| year, you should be able to expenses the costs (including
| salaries) of making it.
| avsteele wrote:
| (1) Capitalization is for tangible assets with a useful life
| and some liquid value. You can't meaningfully monetize the R&E
| of every engineer.
|
| (2) If you analysis held at all you could pull forward the
| deprecation if you abandon the research, which might be viewed
| like disposing of the asset. You cannot do this under this law.
|
| (3) This increases the total cost of R&E work substantially. It
| is a disincentive to innovation.
|
| See also my other post above.
| merritt911 wrote:
| If I'm not mistaken, the amortization period is 5 years for
| domestic 'research expenses', but 15 years for non-domestic
| (foreign). 15 years is a long time...
| hn_throwaway_99 wrote:
| I really, really believe the guidelines for software
| capitalization are totally outdated (even before this change) and
| absolutely need to be updated to reflect how software companies
| actually work today.
|
| The amortization guidelines basically come from old-school
| packaged software and waterfall development cycles, where
| software was first built, and then it was a "finished product",
| and then it was shipped to end users. In a SaaS world, where
| CI/CD is commonplace and things like A/B testing are everywhere,
| and it's basically impossible to distinguish "new development"
| from "maintenance", the whole capex vs. opex for modern software
| companies is a total joke that can easily be gamed in either
| direction. For example, I previously worked for an e-commerce
| company that _wanted_ us to categorize as much dev time as
| possible as CapEx, because it made our bottom line look better.
| The whole thing was a total sham, and it 's not that the company
| was at fault, but it's that the accounting guidelines think,
| wrongly, that software development for most web companies can be
| neatly divided into "research and development" vs. "maint", and
| that is just absolutely not possible given how devs at most
| companies work.
|
| Unless it's basically "shrink-wrapped" software, which largely
| doesn't exist anymore, software that is delivered by a company
| that provides that product online and continuously
| improves/monitors it (i.e. basically all SaaS companies), all
| software dev should be treated as OpEx, period. Anything else is
| just a silly game that doesn't reflect reality. The only
| possibility I can see arguing for CapEx treatment is when there
| is dev before any product actually has been made available yet.
| fdasava wrote:
| > Unless it's basically "shrink-wrapped" software, which
| largely doesn't exist anymore, software that is delivered by a
| company that provides that product online and continuously
| improves/monitors it (i.e. basically all SaaS companies), all
| software dev should be treated as OpEx, period.
|
| You sure about that? If code written 3 years ago is still in
| production, that's not an operating expense, that's a capital
| expense. Kind of by definition. In a mature product, you'd
| expect expenses to shift to opex. But adding features and
| improvements are all classic capex. Just like any other
| industry.
| rrrix1 wrote:
| > "shrink-wrapped" software, which largely doesn't exist
| anymore
|
| Except every commercial operating system, any enterprise
| network or security appliance (physical or virtual), software
| for hardware (firmware, drivers), or pretty much any other
| software that isn't implicitly on or connected to the internet.
|
| A few companies who might find this tax paradigm beneficial
| come to mind: Microsoft, Apple, IBM, Cisco, Intel, NVIDIA...
| Just to name a few.
|
| I generally agree with the overall sentiment; except the ways
| in which software is being built and delivered is changing by
| expansion, but not necessarily changing by replacement.
| GeneralMayhem wrote:
| Every commercial operating system, and the driver for many
| consumer components (especially video cards), receives - and
| are expected by consumers to receive - regular updates for a
| number of years, and requires constant attention to detect
| and address security flaws. For the average user, Windows is
| not all that much less of a SaaS than any web app at this
| point.
| mcny wrote:
| Exactly. The guidance from Microsoft is to literally stop
| using a version of windows ideally before and definitely no
| later than it stops getting security updates.
| koolba wrote:
| Am I to understand from the example that in the simplistic case
| of a single employee C corp in the field of software, one cannot
| deduct the full salary of the one and only employee if any of the
| employee's time is spent working on future initiatives (i.e.
| "research")?
|
| If so, does this still apply to companies operating on a cash
| basis?
| 1auralynn wrote:
| Yes and yes
| qaq wrote:
| Large companies will work around this by putting some entity in a
| jurisdiction with different rules and that entity licensing IP to
| US entity. Small companies will get screwed.
| fritzo wrote:
| The SEC and IRS have penalized this sort of IP gerrymandering,
| e.g. Microsoft's $28Billion fine
| https://techcrunch.com/2023/10/12/microsoft-faces-28-9-billi...
| AnthonyMouse wrote:
| The problem with these rules is that they're unwilling to
| actually provide any principles because of what it would do.
|
| If hiring engineers in California required you to declare
| your global profits in California, companies would prefer to
| hire engineers in another state or another country that
| doesn't do that, so tax authorities aren't willing to say
| that's required because of what it would do to the local
| labor market. But if they don't say that then companies
| declare their profits in Puerto Rico or Ireland.
|
| You can't have it both ways. Governments have to choose what
| they actually want to tax, and then take the consequences of
| companies avoiding doing that in their jurisdiction.
| qaq wrote:
| This is MS shifting profits to avoid paying taxes though.
| ianbicking wrote:
| I feel like I'm kind of bullshitting here because I haven't
| looked into this much or thought about it before reading this
| post, but I left this comment:
|
| Under the logic of this rule, a firm making a software product
| could invest money in software development, produce the necessary
| software, then get income from the software without further
| investment in software development.
|
| In practice this is never the case; revenue gained from software
| needs to be met with further software development to maintain,
| update, secure, etc. the software. Firms that invest in capital
| often have large startup costs that go down as the firm becomes
| fully capitalized. Software development costs seldom go down, but
| instead expand with the firm's success. This is counter-evidence
| to the idea software is capital.
|
| The software produced is also of unclear value and is not
| fungible. If a firm buys manufacturing equipment and the
| enterprise is unsuccessful they can sell the equipment. In the
| case of an unsuccessful enterprise the software almost always is
| of zero resulting value. Given these rules if a firm invests
| money in software development, makes some revenue, but ultimately
| doesn't create a sustainable enterprise, 100% (or more!) of the
| profits could go to taxes with no ability to recoup the
| overtaxing when the firm is dissolved.
|
| Additionally, a firm buying durable goods will be able to buy
| those goods on credit, using the durable good as collateral. The
| tax laws encourage this process and amortization makes sense.
| Software cannot be produced on credit, and in practice can never
| be used as collateral on a loan.
| fdasava wrote:
| It's not really that black and white. The production of new
| software would be capitalized, just like the production of
| basically any other product. Resources/developer time spent on
| maintence would be deducted immediately, however.
|
| And... if you have to write down an intangible asset you can...
| and that will reduce taxes accordingly. You can also get loans
| for intangible assets, use them as collateral, etc. I don't
| understand what you're saying about not producing software on
| credit-- of course you can produce it on credit like anything
| else. You can hire out a firm. Even if you hire a w2 dev you
| typically have 2 weeks to pay them for work done.
| ianbicking wrote:
| Yes, I should have been clearer that it's not that you can't
| make it on credit, but you can't use it as collateral. Firms
| usually buy capital, they don't build it with their own
| hands; this both means different financial instruments are
| available to them, and they can liquidate that capital.
|
| (But as I said, my comment is kind of made up)
| Racing0461 wrote:
| One more of the "regulations" that even though they hurt big
| companies, they can shoulder the cost but small
| companies/startups can't do the big companies will support it in
| order to reduce competition.
| PumpkinSpice wrote:
| How does this interact with the R&D tax credit? Historically,
| companies actively sought to classify a portion of software
| engineering expenses as research, because you received pretty
| generous tax rebates for that _in addition_ to this naturally
| offsetting your income:
|
| https://www.adp.com/resources/articles-and-insights/articles...
|
| This looks like an attempt to reduce that second part without
| touching the first, right? So effectively an administrative
| action to reduce the R&D tax credit passed by the Congress a
| while back?
| dboreham wrote:
| This seems like the most reasonable interpretation of the rule:
| if you're going to use development work done to claim the tax
| credit, _then_ (and only then) you have to amortize said work
| for taxable income purposes.
| gavinhoward wrote:
| This rule is the reason I did not file to make my LLC an S Corp.
| (If that's the right term.)
|
| A regular single-member LLC, such as mine, is treated as one
| entity with its owner for tax purposes. The LLC's income is my
| income, and I just file a personal return for it. This can be bad
| because it puts you in a higher tax bracket.
|
| An S Corp is a way around that. You have the LLC "pay" you a
| "wage," and you pay personal taxes on that, while the LLC pays
| whatever corporations have to pay.
|
| But if your LLC does software, like mine, congratulations! You
| can only deduct 20% of that "wage."
|
| I've been developing my software for years, and I am not done
| yet. I don't have revenue.
|
| So if I went the S Corp route, I'd actually have to pay taxes on
| 0 revenue.
|
| But as a regular LLC, my own work (as the owner) does not count
| as anything taxable, so I'm safe.
|
| If you are going into freelance, perhaps as a consultant, keep
| this in mind. And do submit a comment.
|
| Also, beware of accountants that will try to get you to do
| something that is not in your best interests. I had one or two
| try to encourage me to file as an S Corp, even though they
| admitted this could be a problem.
| chatmasta wrote:
| > So if I went the S Corp route, I'd actually have to pay taxes
| on 0 revenue
|
| You'd only pay taxes if your revenue were more than your
| deductible payroll expenses (which as you say, you estimate to
| be 20% of your salary, which in an s-corp must be a "reasonable
| salary" for work performed).
|
| There's no case where this law causes you pay tax on _zero_
| revenue. The problems require some revenue before they affect
| you, which might actually be another argument against it - you
| 're disincentivized to create revenue from your early product
| if it's not going to be enough to cover your tax obligations.
| gavinhoward wrote:
| Well, I would hope you are right, but that's not what the
| accountants were saying.
| dboreham wrote:
| This is what the parent means by "batshit crazy".
| gavinhoward wrote:
| What parent?
| patmcc wrote:
| No accountant is saying you'd have to pay at literally
| _zero_ revenue, unless they 're very badly misinformed.
|
| The absolute worst case scenario would be having to pay
| taxes as if your revenue was nearly all profit - as if you
| had no expenses (or very few). As always, you only pay
| taxes on 'net income' - revenue minus expenses - this whole
| mess comes about by tweaking how expenses are calculated.
| dboreham wrote:
| Ianaa (I do own an LLC, an S-corp and a C-corp doing software
| though), but this sounds fishy. Besides some details at the
| margin such as payroll taxes, tax treatment (how much tax $y is
| owed on revenue $x) should be roughly the same regardless of
| the legal entity type.
| gavinhoward wrote:
| The accountant explained it this way: did money change
| "hands"?
|
| If money went from the LLC into a "wage," it changed "hands."
| The IRS wants in on that.
|
| If work went from the owner into an LLC, no money changed
| hands, and the IRS doesn't care.
|
| But the very fact that people do S Corps shows that there
| _is_ different tax treatment though.
| rrrix1 wrote:
| Awesome. Thank you for this post. I've recently been stuck on
| this very topic as I begin to explore both consulting and
| building commercial products. I'll be following you!
|
| For the short term (contracting) I'm simply working as a Sole
| Proprietor, but I don't really have much work or significant
| income yet.
| chatmasta wrote:
| You don't need to decide whether to file as an S-Corp or LLC
| or C-Corp until tax time. Don't hesitate to open an LLC if
| you're worried about getting it wrong. It's worth opening an
| LLC immediately just so you can get a business bank account.
| You don't need to worry about the tax implications until you
| actually file them and have to decide which elections to
| make.
| candiddevmike wrote:
| That's not true... There is a brief window for switching
| your LLC to a different tax classification, typically at
| the beginning of the year. It does not change the previous
| year.
| gavinhoward wrote:
| Good luck!
|
| If I may make one suggestion: even if you want to be a sole
| proprietor, look into getting an LLC.
|
| If you run into trouble with a client, a properly-done LLC
| can save your house or other large assets.
|
| With a sole proprietorship, all of your personal stuff can be
| on the hook too.
|
| It's essentially the same advice as keeping separate devices
| for work and for personal use.
| gamblor956 wrote:
| The accountants are not lying to you; you are misunderstanding
| what they are saying.
|
| A single-member LLC and a single-member S-Corp are both
| essentially flow-through entities for a solo entrepreneur.
| However, they are ultimately taxed quite differently: with an
| S-Corp once you exceed the SSI threshold for the essentially
| mandatory portion of revenue you must repatriate to yourself as
| a salary, the remaining income can be repatriated as qualified
| dividend which is taxed at a significantly lower rate than
| directly passed-through income. With an LLC, it's all self-
| employment income subject to regular income taxation, meaning
| that in any realistic scenario, you're paying a higher
| effective tax rate with the solo LLC form.
|
| _So if I went the S Corp route, I 'd actually have to pay
| taxes on 0 revenue._
|
| This is false. The income tax on $0 revenue (meaning no
| revenue, not no profits) is the same: $0. (Note, however, that
| many states have "fees" assessed on business entities like
| S-Corps and LLCs, even single-member LLCs, and in such cases a
| minimum fee is owed regardless of revenue.)
|
| _But as a regular LLC, my own work (as the owner) does not
| count as anything taxable, so I 'm safe._
|
| This is also false. The work you provide to the entity as an
| owner is _still_ an R &D expenditure. The difference is that
| with the S-Corp, the expenditure cost is clearly documented,
| while with the LLC you're pretending that the number is $0 and
| gambling on not getting audited. This only matters once you
| start generating revenue...
|
| Either way, not all of your salary would be subject to
| capitalization. If you have revenue, you clearly spent at least
| some time and work on marketing and business development, and
| expenses for those non-R&D activities are not capitalized.
|
| With the S-Corp, your salary offsets up to [your salary
| assigned to non-R&D tasks less 1/10 [see note] of your current-
| year salary assigned to R&D plus carried-over capitalization
| from R&D from prior years] in revenue each year, and after an
| appropriate amount of salary (generally the SSI contribution
| threshold for the year) the rest of that annual revenue can be
| repatriated to yourself as a dividend at lower tax rates. With
| the LLC form, since you aren't paying yourself a salary, you
| owe tax on 100% of the revenue arising from the software you
| develop without any deductions.
|
| TLDR: If you actually care about tax, S-Corps are _almost_
| always the better option for the solo entrepreneur, and they
| 're still the better option here.
|
| NOTE: Capitalization is on a mid-year convention, so the first
| and last year you only capitalize 1/10th of the cost; and in
| the middle 4 years you capitalize 1/5th of the cost. So, for
| Y2, if you paid yourself $100 in salary both years, your total
| capitalization deduction would be $30: $10 capitalization for
| the Y2 salary and $20 for Y1 capitalization.
| gavinhoward wrote:
| > The difference is that with the S-Corp, the expenditure
| cost is clearly documented, while with the LLC you're
| pretending that the number is $0 and gambling on not getting
| audited.
|
| So if the IRS audits me, they'll say that my work is worth
| something and therefore, I have to pay taxes on it?
|
| Sounds awful.
|
| But I and the accountants I talked to don't think that's the
| case.
|
| Also, I'm not going to take R&D credits, nor claim deductions
| from salary, so why would they care?
|
| And I did the math: yes, an S Corp is _technically_ better.
| But at the revenue levels I plan on seeing, the difference
| isn 't that much (a few thousand), and any revenue gets taxed
| right away, which is more convenient for me. I'll take that
| instead of complicating my taxes.
| gamblor956 wrote:
| _So if the IRS audits me, they 'll say that my work is
| worth something and therefore, I have to pay taxes on it?_
|
| Well, no...since you're not claiming to be making any
| revenue from that work, it doesn't matter. Whether you
| deduct 100% or 20% of your salary from $0 business income
| you still have $0 of taxable business income (and as an
| individual you don't get NOL carryovers so that amount is
| lost to you forever).
|
| In fact, in the event of an audit, you'd likely get a
| refund since the IRS would determine that you're
| incorrectly calculating your tax liability by failing to
| capitalize your R&D expenditure (i.e., your flow-through
| revenue which is entirely treated as self-employment
| income). But, because this error affects other years'
| returns, which means that a one-return audit can turn into
| a multi-return audit. It also means you get put on a very
| special list of taxpayers subject to increased scrutiny
| (meaning, significantly more likely to be audited again in
| a future year).
|
| _But at the revenue levels I plan on seeing, the
| difference isn 't that much (a few thousand), and any
| revenue gets taxed right away, which is more convenient for
| me. I'll take that instead of complicating my taxes._
|
| Yes, the LLC is much simpler when it's a disregarded
| (single-owner flow-through) entity. But it's more
| complicated once you add other members or any employees.
| And as you've pointed out, you're already paying more in
| taxes.
|
| My issue isn't with you choosing to use the LLC form
| because it's simpler, my issue is with you claiming that
| it's better for tax purposes on a numerical basis when it
| is clearly _not_.
| antasvara wrote:
| If you have zero revenue, how are you paying yourself a salary
| from the S Corp?
| fdasava wrote:
| > This has a hugely negative impact for early-stage startups,
| contract research firms (i.e. SBIR companies), and independent
| software developers.
|
| Yeah, but that doesn't make it unfair, no? The whole "develop it
| today, pay taxes on it later" effect SaaS used to have was just a
| loophole software enjoyed for a long time. Developing _anything_
| is investment, and tax code generally requires that to be
| amortized so you can 't deduct it all year 1. Congress just
| closed the loophole for software.
| Apreche wrote:
| The thing that I hate most about this rule, as a developer, is
| that employers keep trying to get me to track all my hours of
| work. They do this to figure out what portion of my wages they
| can claim as capitalized expenses.
|
| That would make sense if I was a consultant, or working for a
| consultancy, and billing someone else for those hours. As a full
| time salaried employee, time tracking is just a pain in my ass.
|
| To make things worse, I believe that few, if any, companies doing
| this time tracking are doing it with any amount of rigor. If an
| auditor really wanted to check, they would find that the claimed
| capitalized expenses are overinflated, and are technically tax
| fraud.
|
| Just remove the rule altogether. A company paying a wage to a
| software engineer shouldn't be taxed any differently than any
| other kind of employee.
| fdasava wrote:
| > Just remove the rule altogether. A company paying a wage to a
| software engineer shouldn't be taxed any differently than any
| other kind of employee.
|
| In most other industries, product development is capitalized
| and amortized over the life of the product for tax purposes. It
| requires lots of estimation and log-keeping (X% spent on
| develpoment, 100-X% spent on maintenance). Which is exactly
| what your employer is doing... taxing you just like every other
| kind of employee.
|
| The change just removed the specific loophole for software.
| spac wrote:
| Except that for software this is so much more complex than
| for any other type of products.
| PaulDavisThe1st wrote:
| To try to clarify for anyone reading about this for the first
| time ...
|
| this all hinges on whether language in the tax code is
| interpreted one way or another.
|
| Way #1: companies often try to claim many deductions on R&D
| expenditures, and the changed language makes it clear that all
| software development expenses can be claimed as R&D expenditure
| (which was not necessarily clear before).
|
| Way #2: all software development expenses MUST be treated as R&D
| expenditures which requires claiming them as an amortized
| deduction (over 5 or 15 years depending on where they happen).
|
| Neither the IRS nor Congress has clarified the intent of the
| change, and there are solid arguments for both interpretations.
| Way #2 is supported by the use of "shall" in the language used.
| Way #1 is supported by the fact that Way #2 is batshit crazy.
|
| It seems that a lot of people are convinced that Way #2 is the
| intended one, despite its catastrophic implications for many
| software-based companies.
| dboreham wrote:
| Thanks for posting this clear explanation. Every time this
| comes up it's frustrating to see commenters assume that it's
| certainly intended to be way #2.
| dataflow wrote:
| If it's so crazy that people think "shall" couldn't have
| possibly been meant to be taken literally, (why) is there no
| court case about it? Is that not possible at this stage in the
| process?
| martinflack wrote:
| As a law prof once told me, "shall" can end up being
| ambiguous in court, despite the common understanding.
|
| I'm sure this isn't the best tutorial on the topic but it
| gives you a taste: https://www.barandbench.com/columns/shall-
| shocked-the-use-of...
| dataflow wrote:
| > As a law prof once told me, "shall" can end up being
| ambiguous in court, despite the common understanding.
|
| Perhaps it can be can be made ambiguous in some context if
| you try hard enough, but that doesn't mean it commonly is
| so, or that it is here.
|
| > I'm sure this isn't the best tutorial on the topic but it
| gives you a taste:
| https://www.barandbench.com/columns/shall-shocked-the-use-
| of...
|
| Thanks, but the only thing that link gave me a taste for is
| terrible strawman arguments. (Or a severe lack of
| understanding of basic English.)
|
| If you have "shall be" in a sentence, then that phrase is
| the verb of interest whose ambiguity (or lack thereof) you
| must examine, not the "shall" on its own. Claiming "shall"
| is ambiguous because it changes meaning when you put "be"
| after it makes no sense. It comes across as the kind of
| argument a first-grader would make.
|
| They write: _If the substitution rule is applied in the
| sentence: "The employee shall be reimbursed all expenses",
| you would get: "The employee has a duty to be reimbursed
| all expenses". This created ambiguity for the simple reason
| that the intent appeared to state an entitlement of the
| employee and not to impose a duty on the employee._
|
| Do they lack common sense when reading this, or do they
| struggle with English? It's like claiming "I have a carrot"
| is somehow ambiguous because "I have been a carrot" means
| something entirely different. Does that sentence need
| disambiguation with "I possess a carrot" or "I have a
| carrot, but have not existed, as a carrot"? Are these
| serious arguments?
| torstenvl wrote:
| Agreed. Their analysis inappropriately conflates the
| syntactical subject of a sentence with the semantic agent
| of the sentence.
|
| It also violates the fundamental rule that changing a
| sentence into the passive voice does not effect a
| semantic change.
|
| "The employee shall be reimbursed [by the employer] for
| all expenses." _must necessarily mean_ the same as "The
| employer shall reimburse the employee for all expenses."
| pama wrote:
| I think that in the first (ambiguous) phrasing there is
| an implicit (common-sense?) understanding of: the
| employee shall be reimbursed for all expenses if the
| employee asks for it or wants it, ie the employee has the
| right to ask for and only then the employer has the
| obligation to reimburse all expenses.
| pclmulqdq wrote:
| I'm pretty sure way #2 is the letter of the law, but doesn't
| apply to a lot of kinds of software development that fit into
| the general sphere of "maintenance," only to new development.
| PaulDavisThe1st wrote:
| I should add that's there is also vaguely middle-ground
| interpretation, which goes something like:
|
| Way #1.5: if a company chooses to take R&D expenditures _of any
| type_ as a deduction (which it is not required to do) then it
| MUST include software development expenses (which in turns
| means they will be amortized).
| yieldcrv wrote:
| unless they aren't deducting software development at all
|
| there is no obligation to take a deduction. if you find
| yourself in a circumstance where its more favorable to not
| take a deduction then you don't have to report that
| transaction
| PaulDavisThe1st wrote:
| this is the whole crux of the matter. interpretation #2
| says that the law now says that you MUST ("shall") consider
| all software development expense as R&D expenditures that
| are amortized over 5/15 years.
|
| i personally believe that the intended/appropriate
| interpretation is #1 - you MAY consider software
| development expense as R&D and include in an R&D deduction
| if you choose to take one.
|
| but it is far from clear what was intended and/or how the
| IRS interprets it.
| Ldorigo wrote:
| Can you explain to someone not familiar with US tax law why #2
| is batshit crazy?
| PaulDavisThe1st wrote:
| #2 would imply that anyone who chooses to engage in software
| development (either personally, or contracting others to do
| the work) cannot consider the expenses to be regular (non-
| amortized) deductions.
|
| This means that you cannot, for example, pay yourself a
| salary and have that treated like the salary you would
| receive if, for example, you had chosen to be a builder or an
| artist or a massage therapist.
|
| Another commenter here touched upon what I assume would be
| the justification for this: with software you spend Y years
| and C money to develop it, then you sit back and collect
| revenue, therefore the C money you put it at the beginning is
| a capital expenditure. But that's rarely the case with any
| software. Either it is a perennial, on-going process that
| never stops, or it ceases to be a revenue source. There are
| exceptions (especially since the dawn of mobile apps) but
| they are not the rule.
|
| It's also not clear precisely what the difference is between
| working as a self-employed software developer and a self-
| employed architect is. They are not exactly the same, but why
| the former should not be able to take a regular salary from
| the revenue available, and the latter can doesn't seem clear,
| let alone equitable.
|
| If anyone has actually thought about things this way, they
| seem to have a model in their mind that all software
| development is done following a process of "build first, sell
| later". This just isn't an accurate reflection of how a lot
| (most?) s/w development takes place.
| codazoda wrote:
| Does this rule encourage off-shoring? Meaning that contract
| developers just invoice you and you write that off as any other
| expense, or does it apply equally there?
| creer wrote:
| "Just as any other expense" meaning that it's a software
| development expense. I don't think it matters much in US tax
| whether you do it in house or not.
|
| It might matter if you buy finished software modules and
| integrate and resell them.
| PaulDavisThe1st wrote:
| If the interpretation that all software development expenses
| MUST be treated as R&D expenditure and claimed as a deduction
| is correct (which it might be, but it might not be), then it's
| worse for off-shoring because the amortization period is 15
| years. That is, you paid off-shore contract developers $100k,
| you can only deduct $6667 of that in any given year, over the
| next 15 years.
| ImPostingOnHN wrote:
| This is also a problem facing recipients of government grants.
| The government will give you the 100k you ask for, let you spend
| it on what you planned to, then tax 80k in revenue (100k with 1/5
| years amortized), asking you to give some of it right back to
| them (like the post says, you are forced to amortize your
| expenses over 5 years, even if they were all in year 1). Why?
|
| Now academic research needs to consult on tax implications and
| have some set aside.
| mijustin wrote:
| If you're the owner of a small software company, there's a group
| of us that have been petitioning congress.
|
| You can sign the letter and send it to your representative here:
|
| https://ssballiance.org/
| iusuallylurk wrote:
| I believe there are only 43 because they require "review" before
| being posted officially.
|
| It is likely that they do not approve the majority of comments, I
| submitted one but it has not yet been approved.
| burroisolator wrote:
| Does it help to submit duplicative arguments? I see some pretty
| strong arguments in the comments already. I wish there was a way
| to just upvote an existing comment.
| devoutsalsa wrote:
| Can I get a tax refund on $0 revenue for deleting code?
| riku_iki wrote:
| > Revenue: $100k > Expenses: $100k (developer salaries) > Net
| operating income: $0 > Taxable income: $100k - 0.1x100k = $90k
| (first year deduction is 10% of SREs)
|
| And idea is that your deductions you lost here will be applied in
| next 5 years.
| mjwhansen wrote:
| To add to this: please contact your Representative and Senators
| and tell them to tell Congressional leadership to fix R&D
| spending by the end of the year.
|
| Congressional staff are required to keep tabs on everyone who
| calls in about an issue, so your time is well-spent.
|
| The November 17 continuing resolution is our best chance to get
| this fixed, but only if enough members of Congress hear from
| their constituents about it!
| spac wrote:
| I have submitted a comment to the Notice, as well emailed my
| Represenatives and state Governor. I urge every one to do the
| same, this is absolutely bonkers and I agree that it will
| severely affect the startup ecosystem.
| dv_dt wrote:
| Do you actually need software salaries to be treated as R&D vs a
| more regular salary expense? (I'm not an accountant so I'm not
| even sure I'm using proper terminology) I understand there maybe
| be other non-salary sw-dev expenses too...
|
| Does an R&D classification give different tax accounting options
| at least for the salary part?
| sb8244 wrote:
| That's my big question here. If I don't claim an r&d tax
| credit, does the salary still get treated as r&d?
| avsteele wrote:
| This is about way more than software.
|
| Bear in mind that the way it is written _all_ research and
| experimentation costs would be amortized. So if you have a
| chemist, biologist, physicist or even an engineer it plausibly is
| the case that if you are paying them to develop a new product
| that carries technical risk then their *salary* needs to be
| capitalized!
|
| Good luck coming up with the cash to pay a tax bill on 90% of
| their annual salary. You can't even pull forward the depreciation
| if you abandon the research! Sure, it mostly stabilizes after
| about 6 years if your R&E budget is flat, but even in this case
| there is a huge cost in that you only get to deduct their salary
| in the far future. It is huge disincentive to developing anything
| new.
|
| This is a total nightmare and cost many business like mine an
| absurd amount of money this year. Everyone just filed for
| extension in April assuming this insanity would be reversed
| before the late filing deadline... NOPE!
|
| (NB: it is NOT necessarily tied to R&D, or the R&D tax credit.
| The calculation of this is subject to different rules.)
|
| I don't even know how large companies found the cash to pay this
| bill. How can a biotech or software company whose annual expenses
| I'd guess are largely salary have had the money to pay taxes on
| 90% of their salary budget?
| onlyrealcuzzo wrote:
| Do any other countries do this?
|
| And if not, why would anyone push for this - unless your
| intention is to make sure no R&D happens inside the US.
|
| Who's pushing for this?
| walterbell wrote:
| A recent letter signed by trade associations, small and large
| companies from multiple U.S. states, covers three points
| including R&D expenses,
| https://documents.nam.org/TAX/2023%20Tax%20Priorities%20Sign...
| 1. For nearly 70 years, the tax code recognized the importance of
| R&D by allowing businesses to fully deduct their R&D expenses in
| the same year they were incurred. Unfortunately, starting in
| 2022, the tax code has required businesses to amortize (or deduct
| over a period of years) their R&D expenses, making R&D more
| costly to conduct in the U.S. ... tens of thousands of jobs are
| at risk if the harmful R&D amortization requirement remains in
| place. As a result of this change, the U.S. is now one of two
| developed countries requiring the amortization of R&D expenses.
| 2. Prior to Jan. 1, 2022, businesses' interest expense deductions
| were limited by section 163(j) to 30% of their earnings before
| interest, tax, depreciation and amortization (EBITDA). Interest
| deductions are now limited to 30% of earnings before interest and
| tax (EBIT). 3. Over the past several decades, the tax
| code has provided businesses with varying degrees of first-year
| expensing (i.e., accelerated depreciation). A 100% deduction for
| the purchase of equipment and machinery in the tax year purchased
| was in place from 2017 through 2022 ... full expensing began to
| phase out at the beginning of 2023 and will be eliminated
| completely by 2027.
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