This is backwards. Capital expenses are amortized because you purchase an asset that will give you value over multiple years. So, for example, if you buy an office building, you amortize the capital expense.

But what this does is says that if the product you created is an asset, the salaries that go into creating that asset should be treated as if it were purchasing that asset. The office building equivalent would be the builder having to treat the salary it paid its labor as a capital expense and amortizing it.

That sounds beyond insane.

That being said, it’s not a material change, if phased in properly, so companies have time to spread their expenses over a period of time.

But it looks like neither was this planned for (not surprising because it’s ridiculous on its face), nor does the legislation phase it in a manner that can be properly absorbed.

In practice companies will get hit hard the first year, but save the equivalent amount over the next 3-4 years. So after 5 years it will be a wash (ignoring the time value of money…factoring in that makes it a loss, but not as much of a loss). The problem is that it will create tremendous cash flow problems as 5 years of tax is paid in 1 year.

> Capital expenses are amortized because you purchase an asset that will give you value over multiple years. So, for example, if you buy an office building, you amortize the capital expense.

Even that seems like a pretty weak argument for what is essentially a tax penalty.

At least for a purchase of a liquid (or somewhat liquid) capital asset, one could, in principle, re-sell it. But most R&D has essentially no direct resale value and is not being done to create a salable asset. It’s done to create knowledge or IP, which, in turn, is used to create something salable.

I assume the purpose of requiring amortization of capital expenses is to prevent abuses like buying an extremely liquid asset, deducting the purchase price, and thus deferring a tax bill.

> The office building equivalent would be the builder having to treat the salary it paid its labor as a capital expense and amortizing it.

If the builder is building the thing for themself, they do in fact have to depreciate over the IRS-provided lifespan of the building.

The software equivalent to a builder is an agency. If the agency is building their own software, they now have to do the same thing. If the agency is building for someone else, they expense the labor immediatley.

>But what this does is says that if the product you created is an asset, the salaries that go into creating that asset should be treated as if it were purchasing that asset.

This is precisely what happens!!

It's not a rebate, it's salary. For a company bringing in 1 million in revenue and paying 1 million in salary, they literally don't have any money in the bank to pay taxes because they haven't profited yet. If they profit the next year because of their new "asset" giving them long term benefits, they would pay then.

Isn't the simple solution to just not give away all of your revenue before you pay your taxes?

The two constants are death and taxes, if you don't have the revenue to pay them at your current burn rate, you either find a way to burn less or your company just isn't viable.

The idea of corporate taxes is to tax profits, not revenue

Which just ends up with corporate accountants structuring the books to minimize "profit".

I for one can't find it in me to get all that upset about startups paying their fair share of taxes instead of artificially inflating salaries to consume all of their "revenue", thereby hoarding talent away from the labor pool that would likely better serve the country as a whole by working in... really anything besides risky chronically unprofitable startups.

Why are you so hostile to startups? Maybe if you could articulate what small software companies are actually abusing when they offset their revenue with wages like literally every other industry out there I could start to understand your viewpoint.

But without that you just seem like you have a chip on your shoulder.

You do understand that if this law were applied to any industry it would similarly kill small companies in those? Like if restaurants had this rule for wages it would devastate smaller, family run restaurants.

I'm simply stating the idea the P's present of "How terrible is this? I made 1,000,000, spent 1,000,000, but now I don't have money for taxes!" is quite literally a lesson any kid should have learned when they first went to the store to buy a $5 candy with a $5 bill and learned the way of the world.

Given restaurants aren't in the business of R&D I don't see why you're trying to make an argument based on applying R&D tax law to them. It's disingenuous, at best.

What's wrong with paying employees more? Income tax is a thing and that's on revenue, not profit. You'll get a bigger cut of that then other expenses. And a bigger cut of that than equity comp and share buybacks where that's cap gains. Income is great!

Are you arguing the government is actually getting less tax this way?

For the economic activity that happened this year, yeah they get more by forcing people to delay recognizing expenses, which is essentially an interest free loan for the irs that they don't have to pay back if the lender goes bankrupt. But this doesn't actually create a new nominal tax increase, in nominal dollars its a wash, and so the question is if the interest free loan is worth the decrease that would result from companies finding more tax efficient ways to pay employees and any decrease in future economic activity this will cause. Corporate tax and cap gains tax are likely lower than the income tax bracket those revenues would have gone to as income.

If the company has high margins and low expenses, then their profits are already taxed. Its not like hiring one SWE makes your tax bill go to zero.

How closely did you read the line items?

In the example given they received a revenue that covers the entire cost of the software. The problem is that they then used that revenue for payroll which would be fine previously as if you make $X and pay $X in payroll then you pay ($X - $X) 0 in taxes and there isn't a cash flow problem.

To stick with the apples-oranges lathe example. Imagine GM got a loan of $1M for the lathe and they can only depreciate 1/5 the cost of the lathe. So come tax time, GM has to pay taxes on their 800K of "profit" since they can't fully count the cost of the lathe against the loan.

Loan example doesn't work because it's not revenue used to buy the lathe. That type of loan situation is exactly what depreciation/amortization/MACRS is for. If the company brings in $500,000 but buys a $1,000,000 lathe with a loan, they have a net cash flow of +$500,000. Their NPV isn't immediately affected by the loan liability because it's offset by the positive value of the lathe asset.

Then they pay taxes on $357,100 of adjusted earnings because under a 7-year MACRS depreciation, it's assumed the lathe lost $142,900 of value in its first year of ownership (under double-declining or straight-line methods).

Your first part is accurate though.

Anyways, this tax law is fucking terrible. W2 Wages should not be capital expenses because you generally won't be using loans to pay them.

In a world where you venture-fund software development, this is fine, since the venture funding isn't revenue. In a world where you fund software development with revenue, this hurts a lot, particularly for young companies (and especially for companies that get research grants, which are revenue).

Established companies can probably debt-finance development the way GM would debt-finance a lathe (yes, large enterprises often use debt to buy everything possible). Small companies likely won't have that benefit. Particularly because that software isn't necessarily a capital asset that can back a secured loan, the way a lathe is.

I point you to IRC 1221(a)(3): https://www.law.cornell.edu/uscode/text/26/1221

Arguably, software fits this definition, and under 1221(a)(3)(C) it would not be a capital asset for most closely-held companies (eg a lot of bootstrapped firms).

Revenue Ruling 55-706 provides that IP created by employees of a corporation does not fall within the scope of 1221(a)(3).

And generally, corporate-created IP is treated as a capital asset on the books. This is in line with how capital assets are generally treated; as other commenters have noted, the expense of building a factory (including the salaries of the construction workers, if employed directly by the taxpayer) is also subject to capitalization.

Considering that this entire discussion revolves around what is and isn't a "capital asset," which itself is a legal term, I would suggest to you that the law is all we have to argue about it. And the law, in general, sucks here.

For most companies, 1221 doesn't apply, but some companies are going to get screwed on this front by having to incur a capital loss to pay for something that is not a capital asset.

In a less legalistic sense, I'm not sure if there are many companies who provide software-backed debt anyway. That would make software less of a "capital asset" than almost any other intangible asset out there.

So then you agree that re-defining the law is the correct course of action, which is exactly what's being done in TFA.

Nobody disputed that...

Also, what are you referring to as "TFA"? The 2023 tax bill?

I'd prefer to get away from the lathe example because it's not actually a great example of whats going on. I solely used it because the person I was responding to used it.

So back to software. If I have an idea for some company (lets say Twitter2.0) and I bring in ~10M in revenue from selling ad slots but I also paid a bunch of programmers ~8M over the course of the year and somehow the rest of overhead/expense was 1M. I think we can both agree 10M > 9M and so my business venture is profitable.

However, come end of year I have book 10M - (1M + 1.6M) = 7.4M of profit. You may wonder how I can book 7+M of profit when I spent 9M on 10M of revenue and this is exactly what this whole thread is about, programming salaries must be amortized.

This leads to the problem I have to pay taxes on 7.4M of profit using the 1M that I actually have left over so as long as the tax rate is below 13% there's no problem but if its any higher than I need to take out a loan to pay taxes.

It might be fine if that's how it long had been, maybe. What's definitely not fine is the sudden change of rules that an entire industry had been relying on for all their expense planning.

Then the argument would be "let us transition smoothly to the new mode". But all we're seeing in these threads is "bad bad no good very bad" with relatively little nuance.

The key problem here is that for 70+ years companies have had the option to amortize or expense these costs. This change was made as an accounting sleight of hand to make the 2017 tax cuts look paid for over a long-term basis, but Congress never intended for this change to take effect. They know it isn't good tax or economic policy.

So now small businesses and startups are being thrown into crisis because Congress has accidentally implemented policy that they haven't gotten around to fixing.

One potential difference is that for many things that are capital expenses (a building for example) a business is likely to take out a loan in order to buy it, so they don't have the full expense up front. A bank is probably not going to loan you money to pay your developers at the same terms they will loan you money to buy a building.

Makes sense, but why not (genuinely asking)? Is it just that the bank can repossess the building if necessary, but repossessing bespoke software is kind of pointless?

Right. The bank can generally resell a repossessed building to recover the loan principal, but repossessed software may be worth literally anything, including zero in many cases. That makes loans for building software extremely risky, which is why software companies are rarely ever funded by bank loans.

What about software written on contract? It's my understanding that a signed contract with a customer to deliver something for $x is usually enough to convince a bank to lend you $x for approximately the length of time until you get paid. IOW if I'm an engineering firm that has a contract with the DOT to design a highway interchange, I can go down to the bank and a get a loan to pay my engineers' salary until we deliver and get paid. Can I do the same as a software shop that has a contract to rewrite the DOT's payroll software? I guess this scenario is still different because I'm (probably) not paying the loan off over several years -- it's more like an inventory loan.

In any case, it seems like the result of these changes (if they stand) will probably be to change in some way the amount /and type/ of software that gets written. If the tax treatment of software essentially requires it to be a capital asset, we will probably see people write more software that behaves like a capital asset: shrinkwrapped software rather than SaaS. This may not be a bad thing.

It really depends of your business. Sure if your are a SaaS company, SAP, Google,... that's the case.

But if you are a small shop that build software for other companies, it isn't. You write the software, get a one off paiement and you'll not be able to get more revenue from it in the future outside of a possible maintenance contract. You can't resale it to someone else.

To summarise, the work of many software companies is akind to the work of design office : you do R&D for someone else. The amortization will have to be done by your customer, not by you.