IMHO the solution is really more simple than people are making it out to be and it’s weird politics among CPAs causing all the distress. To people wiling to challenge their CPAs style of doing things: don’t classify your core expenses as “research and development”. I believe this follows the letter and spirit of the law. R&D is extra stuff you do on top of an already profitable business. When you’re building a product you’re implementing. It’s entirely a semantic problem that has happened because we call the job function “software development” and the tax code uses “research and development” (a different function) as the language. The CPA thing is caused by there being a central source of “doing things” that all the CPAs follow because they’re not qualified to be a tax lawyer and think for themselves. So everyone is stuck in whatever rut their guild’s status quo tax setup for #startups has caused.
You know, this is pretty clearly the right answer. Software developer salaries are ordinary business expenses. There’s some alarming language in the section about deductibility of R&E expenses, but core business functions aren’t R&E.
That doesn't make sense since there is both greenfield development and maintenance development. By this logic we would have to track our hours and write down when we do maintenance work and when we do R&D.
You do, if you want to claim the tax credit. But the R&D tax credit and R&E under Section 174 are two completely different things.
Until 2022, companies had the choice between expensing and amortizing software development under Section 174. (Section 174 specifically calls out all software development as falling under that section.) So they would only time track when they wanted to get the R&D tax credit, which only covers a portion of software development activities. R&D tax credit software development is a much narrower scope than R&E software development. So it didn't matter until now.
“In the case of a taxpayer’s specified research or experimental expenditures for any taxable year” …
Seems pretty obvious to me that the section only applies to what is claimed as R&E. Software development doesn’t have to be claimed as R&E, but if it is, now it unambiguously qualifies.
You don't specify what is R&E, the statute does. It's specified in the next section, and section c(3):
" “specified research or experimental expenditures” means, with respect to any taxable year, research or experimental expenditures which are paid or incurred by the taxpayer during such taxable year in connection with the taxpayer’s trade or business."
and
"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."
Isn't the main problem that this change forces all software development, regardless of purpose, to be classified as R&E and therefore forced to be amortized?
No! That’s what confused CPAs are telling gullible startup founders.
Nothing forces you to classify engineering salaries or even contract expenses under the provisions of section 174 which describe “research and experimental expenditure”. There are some reasons historically why people elected to do that, but that may be a bad idea moving forward and honestly seems rather dishonest to me. No, your Jira clone is not “research and experimental expenditure”, it’s just a fucking database with a UI… just like 97% of all other startups. It’s more like: if you can use section 174 because you spun up a project to research curing diabetes with nano bots, then your software development allocated towards the project also counts as R&E, cheers.
Repeat after me: “my core business is not a research and experimental expenditure, it’s just a normal mundane boring operating expense”.
Honestly people like you posting these articles claiming that “weird legislative inaction is fucking over startups and small business” and further pushing the “all work that involves scripting a computer 110% must be classified as software R&E” narrative in comments, in spite of so many people telling you that such a conclusion is batshit stupid, makes me question whether there’s some ulterior motive in play. Like what, are all the accounting firms realizing their CPAs don’t outperform TurboTax if they can’t use their secret software R&E magic loophole and have thus deployed the shills, who show founders ridiculous mega tax bills..obviously perturbing them into posting their re-shills? Anecdotally, I know exactly zero founders who are getting “fucked over” by this because they aren’t stupid enough to structure their taxes in a way that causes their employees’ salaries to magically become capitalized voodoo money. Like, man, cut the histrionics… and find a better tax person.
Whether you can shop around to find someone who can tell you what you want to hear is unrelated to the mixed fact and law question of whether it is a defensible position that software development salaries must be capitalized.
In the UK the relevant document is CIRD81900[0] which sets out what conditions must be satisfied to qualify for R&D tax relief. It's lengthy, but worth the read.
One section that stands out is:
"A process, material, device, product, service or source of knowledge does not become an advance in science or technology simply because science or technology is used in its creation"
Unsure if you were getting at this too, but software development in the UK can absolutely be ineligible for R&D tax credits yet still require treatment as capital expenditure for tax purposes (and thus not simply fully deductible in year 1 like revenue expenditure) - see [0] from the AAT on this.
Disclaimer: Not an accountant, not your accountant, get professional advice.
Yeah we've helped hundreds of start-ups do their R&D claims, and you have to have specific projects that fall within the definition of "novel" and even then you need to explicitly specify exactly which people worked on it and for how long. It's not a blank cheque at all, and they've tightened the requirements this year on top of that.
> software development in the UK can absolutely be ineligible for R&D tax credits yet still require treatment as capital expenditure for tax purposes
Indeed. Although:
"If businesses develop their own software, the classification of expenditure relating to this (including salaries of in-house IT staff) should be assessed following the same principles. The fact that expenses such as salaries may be recurring does not on its own prevent them from being capital in nature. However, it should be noted that:
The salaries of IT staff will not normally be capital expenditure unless some major new project can be identified. If staff are making only piecemeal changes or minor improvements to software, their salaries are likely to be revenue costs."
Yet from the [US-based] contibutions in the thread it sounds as though _all_ in-house software developers' salaries may _have_ to be treated as capital expenditure for tax purposes in the US.
This seems, frankly, bonkers. I appreciate that portions of the US tax code might well be exactly that(!)
In NL, there's a tax relief for R&D, but it will have to be approved on forehand, and has to be described and estimated in detail, and will be audited. The tax relief gives you a discount on employee taxes.
This is categorically untrue, many developers are COGS.
> The salaries of the team responsible for keeping the production instance of the software up and running should also be included in COGS. All other R&D expenses should not be in COGS.
> Amortized software development costs (we discourage capitalizing these costs in the first place)
Emphasis mine. They're saying if you amortize your other software dev as R&E (stuff that isn't ops/infra/etc. and thus considered COGS) then it doesn't count towards your COGS. But then what they're pretty clearly saying in the parenthetical is that they don't recommend doing that in the first place, which implies that you have a choice.
> 174(c)(3)SoftwareDevelopment
> 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.
My understanding is the problem is the phrase "any amount paid or incurred in connection with". It is unambiguous and provides no leeway. Any costs related to software development are R&D. Period.
The ambiguous part is "the development of any software". What does "development" mean? Is it used in the same sense as "real estate development" or "software development"? Does "development" include maintenance of existing software? As everyone here knows, software development (the profession and practice) is a lot more than just greenfield projects to create brand new products and IP.
> 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.
Where "this section" is "§174. Amortization of research and experimental expenditures"
> Where does it say that all your business expenditure must be considered R&E and consequently are subject to the provisions of section 174?
It doesn't, and neither did I. It states that all software development is seen as R&E
> Yes, if some of your expenditure falls under R&E, then you use section 174 which says any portion thereof involving software development must be amortized.
> What’s described is a cause and effect relationship, not a global mutation of all expenses.
That's not how I interpret it. Section 174 states that all sw dev will fall under R&E. By your logic, you could rule out any "Special rules and definitions" of all sections.
Again, it's not about "all expenses". It's about "any amount paid or incurred in connection with the development of any software". Basically payroll, contractors, and even outsourced companies.
To prevent massive outsourcing, the amortization rate is 7% (15 years) instead of 20%.
Look at it this way:
A "machine" must be amortized. In its lifespan it wil generate some sort of income (almost by itself).
Software can be seen as a "machine". Makes total sense.
Here in NL, if you mine bitcoin. You'll have to pay income tax over it, as it's seen similar as "labor".
> In the case of a taxpayer’s specified research or experimental expenditures for any taxable year—
Note specified.
Then the special rule says
> 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.
So the section says its purpose is to govern specified R&E expenditure. And the special rule regarding software is caveated to make it clear that it is subject to the general purpose of the section.
To your analogy, if I pay an employee to build a machine rather than buy a machine, that’s opex not capex. I don't amortize the labor cost of the machine out over 5 years and pay taxes on the 80% of the employees salary that now doesn’t count as an expense because they made a machine. I also don't get to add the value of the machine as an asset and record losses as it depreciates over the years, either.
But in "(b) Specified research or experimental expenditures" it says:
> For purposes of this section, the term "specified research or experimental expenditures" means, with respect to any taxable year, research or experimental expenditures which are paid or incurred by the taxpayer during such taxable year in connection with the taxpayer's trade or business.
So that's R&E expenditures. It's further specified that all swdev is R&E.
My interpretation would be that sw dev = R&E. And R&E = specified R&E, UNLESS it's not in connection to the trade or business. (Not sure when that would happen though).
Afaik, it works like that when activating any piece of IP using an expenses based valuation method.
I'm gonna let it rest now. I'm not affected anyway. At least not directly.
Where does it say that all your business expenditure must be considered R&E and consequently are subject to the provisions of section 174?
Yes, if some of your expenditure falls under R&E, then you use section 174 which says any portion thereof involving software development must be amortized.
What’s described is a cause and effect relationship, not a global mutation of all expenses.
Stop parroting this nonsense. If you really think gluing a React UI onto MongoDB and then jamming it into an Electron app so that you can charge a subscription for your juice-pulp-bag-squeezing-machine is “research and experimental expenditure” you have either drown yourself so far in Kool-Aid that your skin is blue or you’re certifiably committing tax fraud.
> 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.
This section describes how to handle expenses you consider to honestly be research and experimental expenditure. It does not supersede all other sections of the tax code and magically cause all software expenses to get sucked under this section. It simply instructs you how to proceed when evaluating your R&E expenditure, of which software development unambiguously qualifies.
Section 174 literally begins with
> In General
> In the case of a taxpayer’s specified research or experimental expenditures for any taxable year—
And this section is "26 USC 174: Amortization of research and experimental expenditures"
Why is it so hard to believe? The US has a credit problem. There's a ton of money going to software dev. It gives the government some easy access to capital. It's essentially a loan from tech companies
Amortization of research and experimental expenditures applies to research and experimental expenditures. It doesn't apply to the money you spent paying a contractor to hook your PoS and Shopify into Stripe. If you’re researching how to cure brain cancer by experimenting on rats with gene therapy, then yeah, you might consider organizing your expenses under the provisions of section 174. But even then it’s not a requirement.
@dcow, sure, but it says, and that's what all the fuzz imo is about:
"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."
I certainly agree the wording is wholly suboptimal and confusing, but what I don't understand is the determination to pick the obviously borked interpretation, especially after clarification is given. There is no honest fair rational interpretation of the tax code that would result in needing to e.g. capitalize your IT team’s salary because they wrote a script to provision employee laptops. It can’t be interpreted that way because it’s not just. The for the purposes of this section caveat is really important. But also, pulling one sentence out of the document out of context is also somewhat fraught. The government isn’t allowed to steal money from software companies just because. That’s not remotely close to the spirit of the tax code.
PS: if the reply button doesn't show up click the timestamp (X minutes|hours ago) on the comment you’re wanting to reply to and you’ll get a reply option.
Was clarification given? If so, it would be rather strange to see these posts pop up on cnbc and other big sites, as it was already known and discussed some time ago.
I think that's up to the judicial branch to see if the new law/regulations are unconstitutional.
Whil I do agree it's messed up, but they're not really stealing, they're just borrowing from companies. Timing is pretty shitty though; a year or two ago, it would've made less of an impact, as capital was cheaper and easier to get.
Is borrowing the right term here? You don't get the tax you paid on your phantom profits back if you lose money the next year. You just pay marginally less tax if you make money. You’re spending money you would never have spent. A loan implies you get repaid.
That’s what is really fucked up as others are pointing out. If I don’t grow or grow slowly The gov’t is flat out robbing me. If I start a venture that I don’t expect will start generating revenue for 5 years, then the government has taken 5 * 1/5(sw-expenses)(tax-rate). Thats not a loan, it’s larceny.
>> All sw dev is considered R&E. Soo you have no choice
You certainly have a choice to claim it as such or not.
More importantly, why TF has the government been paying software engineers salary all these years? That's the real question. Also, has it occurred to anyone that this may be why the big tech companies are laying off engineers in droves?
The government has not been paying software engineer salaries in any sense. This is in regards to profit calculation where business typically pays taxes on profits, so a zero profit company whose largest expense is developers gets a "fuck you, go out of business now" tax bill.
26 U.S. Code § 174 - Amortization of research and experimental expenditures
(c) Special rules
(3) Software development
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.
Guys, this entire section is under the ITEMIZED DEDUCTIONS FOR INDIVIDUALS AND CORPORATIONS section. Taking a deduction is never mandatory (though usually recommended if applicable). Context matters.
> In computing taxable income under section 63, there shall be allowed as deductions the items specified in this part,
Generally, these sections explaining deductions, including 174, are things you adopt. From the beginning of the section
> (a) In general
> In the case of a taxpayer’s specified research or experimental expenditures for any taxable year—
Everything that follows is subject your specified R&E. Which is all part of the itemized deductions framework which is all completely discretionary.
For instance, here’s section 162
> a) In general
> There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including—
> (1) a reasonable allowance for salaries or other compensation for personal services actually rendered;
You are simply carrying on business ordinarily. People don’t operate businesses on R&E expenditure. It’s just not a rational interpretation of the tax code and you don't even need to be a lawyer to read this document or form that conclusion.
I was referring to the statute, in that you shall capitalize R&D. That's not just the plain language of the statute [1], or how the Congress who passed it interpreted it [2], it's the plain language as the IRS describes it in Pub 535 [3]:
> Research or experimental expenditures paid or incurred in tax years beginning after December 31, 2021, must be charged to a separate specified research or experimental capital account and amortized ratably over a 5-year period ... The expenses cannot be deducted in full in the current year.
> Research or experimental expenditures, as used in section 174, are research and development costs ... you incur in connection with your trade or business [..] The costs related to developing software are treated as research and experimental expenditures.
Nothing contradicts this plain meaning. Rev Proc 2023-11 [5] just reiterates that yes, all software development is included in R&E expenses:
> 2.02 (5) Section 174(c)(3) provides that for purposes of § 174, any amount paid or incurred in connection with the development of any software is treated as a research or experimental expenditure accounted for under the required § 174 method.
And yes, no deduction is allowed:
> 2.02 (1) As amended by § 13206(a) of the TCJA, § 174(a)(1) provides that in the case of a taxpayer’s specified research or experimental expenditures for any taxable year, except as provided in § 174(a)(2), no deduction is allowed for such expenditures.
The sad part is that it's not even that much money. The Joint Committee estimates [4] that it will gain about 12 billion per year on average, but most of that is front-loaded into TY22 and 23. So they force larger companies like Google to hand over their cash so they can collect the float on it or whatever, and they don't care it will fuck over all these startups. They probably modeled it in.
