Now imagine that a restaurant buys 100 tables, 500 chairs, kitchen equipment, cutlery for 800 people, signage, a security system, and does a remodeling before opening. (Or an airline buys an airplane. Or a hotel chain builds a hotel.)
Should they be able to expense all of those items that provide value for multiple years in a single year?
Does software development provide value exclusively in the year it's done? Or over multiple years?
The reason that we require you to deduct an expense over years for some things is because they have a resale value that needs to be accounted for. It's not a pure expense because you have an asset with real value that came out of the purchase. Employee time has no resale value. Once used it's gone, so employee salaries are expenses, not investments.
The only possible justification for the Section 174 R&D changes is that employees working in R&D theoretically are producing something which does have a resale value, so there's a small tax dodge enabled by direct-expensing your R&D costs but then ending up with an infinitely-copyable asset that came out of it.
If that's what you're saying, then I'd reply to that argument by saying that paying humans to design new things has historically been a business strategy that the government has wanted to incentivize in a way that buying and holding physical assets has not been. I've seen no justification for the government deciding that from 2022 on we should actively discourage R&D, it just seems to be a mistake.
Software is like Art, it doesn't have value until sold or can be used. If they sell services based on the software, they are generating revenue and then taxation on that revenue can occur.
Same as if they sell the software, either as a copy or ownership.
But not being able to take salary as a business expense seems like as thing that would happen if software in and of itself has value, which is largely does not.
> But not being able to take salary as a business expense seems like as thing that would happen if software in and of itself has value, which is largely does not.
To me it seems like a thing that just wouldn't happen. Forget software.
Say you own a McDonald's, and as part of your operations you have some people on staff to take orders, prepare food, and clean the bathrooms. Why are their wages not a deductible business expense?
If the answer is "they are, don't be stupid", then... what exactly was the R&D tax break?
> I've seen no justification for the government deciding that from 2022 on we should actively discourage R&D, it just seems to be a mistake.
Removing a specific tax exemption to create a level playing field isn’t discouraging R&D.
That’s the thing, every year such exemptions exist the US taxpayers are handing out money. Just because we subsidize say EV’s or Corn doesn’t mean that’s the baseline forever more.
> Removing a specific tax exemption to create a level playing field isn’t discouraging R&D.
If the end result of removing this exemption is that there is less R&D done in the US, then yes, empirically, removing the exemption discourages R&D. Assuming the mass layoffs were indeed fueled by the removal of this exemption (I don't know if the article is correct or not), then it is reasonable to assert that it is true that removing the exemption has reduced the amount of R&D done.
Or, you could also say that the "default state" is some low level of R&D, and the tax exemption encouraged and incentivized more of it.
Either way you slice it, though, the status quo prior to 2022 was some level of encouraged/incentivized R&D. That status quo changed to encourage/incentivize less R&D, and companies have followed these lack of incentives and have fired a lot of their R&D staff. Is that a good thing for the US? I can't see how it could be.
> empirically, removing the exemption discourages R&D.
Not clearing a road means fewer people use it, but you not going out with a shovel to clear a public roads isn’t you discouraging their use nor is you canceling your plans to clear said roads.
It didn’t create a level playing field, it just discouraged a very specific type of R&D while ignoring all others. All other types of employee salaries follow certain rules and some can optionally follow R&D rules. Software is now the only one required to follow 5 year R&D amortization so the deck is now stacked against software.
The default situation is whatever was yesterday. I’d be astonished to learn that even a single significant civilization functioned without subsidies or patronage of priorities held by a society’s leaders.
Those subsidies lasted a long time, but just as with a TV they didn’t last forever.
So if your argument is some subsidy will probably happen next year sure, but individual subsidies change over time. No specific subsidy is the default.
Level playing field for whom? Who does incentivizing R&D disadvantage?
Restaurants weren't competing with R&D-heavy corporations in any way. R&D-heavy corporations competed with each other, on a level playing field where all of them can build new stuff without having to pay taxes on negative income in their early years.
The only change this has made is un-level the playing field in favor of old, established corporations that already have the revenue streams in place to fund their new R&D projects.
Taxpayers who end up with the bill and every company is competing for workers, office space, etc. Incentives across decades shift what people study, what business get created, etc. R&D sounds great abstractly, but it’s not some panacea where unlimited funding results in pure gains.
The economy is generally more efficient without central planning, and dumping money into anything that can be classified as R&D is simply inefficient.
> every company is competing for workers, office space, etc
My company is all-remote and none of us would work for a company that isn't doing R&D. Most of an entire profession now has to be amortized over 5 years.
> The economy is generally more efficient without central planning
The old tax code isn't "central planning", it just had the very reasonable property that the government wouldn't force you to pay taxes on a loss.
This scenario [0] is now possible. It wasn't before. That is a catastrophic level of stupidity, and you can't justify it with invisible-hand nonsense.
> none of us would work for a company that isn't doing R&D
So you’d just be unemployed for the rest of your lives? That’s a possible edge case not worth adjusting the tax code for, but it seems unlikely.
> wouldn't force you to pay taxes on a loss.
R&D is an investment, you only pay taxes if the rest of the company is profitable.
If your company is spending 1M / year on R&D and not adding 800k in long term value then in theory you’d be correct. But at that point you either aren’t doing R&D, or are doing such a poor job of it that the government shouldn’t be encouraging that activity.
The problem here is that all software development (excepting that done for hire) is classified as R&D. The software developer working on your Wordpress or Magento site (and arguably the accountant building a spreadsheet, to take the statute at face value) isn't an operational expense, they're now an R&D expense that has to be amortized and can't be taken as an expense against revenue. Previously, this was an optional choice (and many large and mature companies were amortizing anyway), but under the current tax treatment it's required, which essentially turns early-stage startups into cash bonfires, given how many small companies don't make it to year five.
As a practical measure it’s really not. The transition is difficult for existing companies, but a future startup is going to be minimally impacted.
Year 0 you’re unlikely to have any profits, future years you have multiple years of R&D to offset with.
But let’s assume the worst case. Taxes are 21% of profits and at minimum deduction 20% of R&D so the theoretical maximum distribution is 0.8 * 0.21 = 16.8% increase in R&D expenses if profits = R&D year 0. But that maximum case is only year 0, you’d be able to fund R&D with those same profits and easily be profitable after that.
If profits where say 40% of R&D in year 0 you’d have to pay 16.8% of 40% so an increase is only 6.72% hardly likely to tank the business if it’s already generating that kind of income year 0, and again after that point you’ll deduct for multiple years.
More realistic numbers are going to be really low multiples here, more importantly they represent significant investments not operating expenses.
> Year 0 you’re unlikely to have any profits, future years you have multiple years of R&D to offset with.
You're only unlikely to have no profits if you have no revenue. And you only get to break even 5 years in, which most startups will never reach.
In practice what is likely going to happen is that we'll see more and more startups deliberately avoid revenue in the early days. More and more free tiers followed by rug pulls when revenue actually becomes an asset rather than a liability.
There is no unplanned economy, only different outcomes from better or worse plans. And I'm having a hard time imagining a worse plan than one that intentionally disincentivizes businesses from adopting a sustainable business model early in their lifetime.
> unlikely to have no profits if you have no revenue.
It’s much easier to have revenue than profits, set the price lower and suddenly zero profit. Some company avoiding profits because of the 21% tax on profit like that would be mathematically dumb.
> There is no unplanned economy, only different outcomes from better or worse plans. And I'm having a hard time imagining a worse plan than one that intentionally disincentivizes businesses from adopting a sustainable business model early in their lifetime.
There’s zero advantage to avoiding revenue or profit here. You’re tilting at windmills.
You simply need less investor money for R&D when other parts of the company are profitable. As to central panning, the mistake you just made is mitigated when many people are all independently making plans. Governments always need to get it right, the market is fine if some people get it right and therefore can reinvest in their success.
It sounds like you’re talking about government funding of research? This is about private companies funding the costs of making product ideas into actual sellable products.
Are you asserting that software and other labor-heavy startups should raise additional private capital so that they can pay taxes before they’ve established themselves in the marketplace? I’m not sure what you mean to say exactly.
I’m saying investers should pay the full cost of R&D without assistance from taxpayers.
When the non R&D portion of the business is profitable they should start paying taxes. Assuming a company isn’t miss classifying operations as R&D it shouldn’t be a major issue.
This will of course discourage “riskier” startups and dampen innovation and give more power to profitable incumbents who will have less incentive to innovate. (Perhaps the result of this looks like Europe?)
What specifically do you disagree with? That R&D is an investment? I mean outside of the tax code that’s what it means to do R&D.
As to my other point, the highest risk category of startup has zero customers for years they also have zero revenue, zero profit, and zero taxes to pay here. On the 5th year they can deduct R&D from each of those years making the net effect on them minimal vs a startup with profits on year 0.
> The economy is generally more efficient without central planning
Big fat "citation needed" there. I know you chose the term "central planning" to try to invoke the communism boogeyman, but overall, free markets do not exist, and have never existed. Governments constantly use various levers (taxation being one of them) to encourage or discourage certain kinds of business activity. This is nothing new, and I find it laughable to suggest that this kind of thing should be done away with entirely.
There’s a lot of evidence for this outside of communism. Housing markets for example are a clear example of economic inefficiency created by subsides. But you also see problems with farm subsidies, flood insurance, and a host of other related issues.
Markets operate on revealed preferences, which is just a massive advantage in terms of giving people what they want. There’s definitely a role for governments in economies around information asymmetry, safety, etc, but allocation of resources specifically doesn’t work well.
> I've seen no justification for the government deciding that from 2022 on we should actively discourage R&D, it just seems to be a mistake.
My understanding is that this was done in order to balance the tax bill passed by the Trump admin due to a requirement to be budget neutral. Cut tax revenue here, increase tax revenue there.
What about construction worker and other labor time to build a factory? That’s the analogy being made here by the tax code: Software whose development is a capital expense with value returned over time.
From a quick search it appears to me like construction labor is deductible as an expense in the year it is incurred. Do you have evidence that says otherwise?
My reading of § 1.263A-1 is that construction labor must be capitalized.
§ 1.263A-1.a.3.A indicates that it's in scope: Real property and tangible personal property produced by the taxpayer
§ 1.263A-1.e.2 specifies that Direct Costs are subject to capitalization: Producers. Producers must capitalize direct material costs and direct labor costs.
(I'm just a taxpayer, not a tax lawyer or even an EA or CPA.)
What tax code references or treasury regulations did you find to support your belief that construction labor can be expensed in the year performed?
> Dear ChatGPT, is construction labor deductible as an expense in the year it is incurred according to GAAP? Please answer in a few lines.
Under GAAP, construction labor is not immediately deductible as an expense in the year it is incurred if it relates to the construction of a long-term asset (like a building). Instead, it is capitalized as part of the asset's cost and then expensed over time through depreciation. Only labor costs not tied to asset creation (e.g., routine maintenance) are expensed as incurred.
Unfortunately my understanding of the R&D expensing rule is that it is lifted directly from GAAP, which means private companies have to adhere to those (heavyweight) rules to comply.
Fair point. I changed the question to "according to the tax code" and it told me that
Construction labor is generally not deductible as an expense in the year incurred if it is related to the construction or improvement of a capital asset (like a building). Instead, under the U.S. tax code (IRC §263A), these costs must usually be capitalized and recovered through depreciation over time. Exceptions may apply for certain small taxpayers or repairs.
It's only shifting what year the government gets its revenue. The government should simply let the company choose how to do it, but if they choose anything other than year 1 interest will be payable at government bond rates.
It's also massively shifting the companies' cash flows. The company paid $X for R&D this year, but for tax purposes 80% of that $X expense is moved to next four years. So for this year's tax purposes, the company R&D expenses are much lower than what the company paid.
Ironically I think they would want to claim that over multiple years unless they have other profitable operations under the same company. E.g. other restaurants.
Imagine a restaurant spends money on employees to build 100 tables, 500 chairs, etc. Those tangible goods would be capital assets, so the labor costs of building them would also be capitalized.
This change to the tax code is just bringing the tax treatment of software development in line with how every other industry is treated. IOW, it was closing a loophole. A very valuable loophole, whose beneficiaries used it to get filthy rich, and bragged about how their industry was so much more valuable than everything else, even though a lot of that value was due to the exception software was getting in the tax code.
Notably, in the current version of the budget as of 6/6, the loophole is temporarily coming back, though given the Musk-Trump feud, it's very possible it will get pulled again to try to mollify the hardline deficit caucus.
Should they be able to expense all of those items that provide value for multiple years in a single year?
Does software development provide value exclusively in the year it's done? Or over multiple years?