As a non-American, it seems strange to me that the cost of regular software development, i.e. that is neither “research” nor “experimental” in a conventional sense, would be deductible in the first place (amortized or not). Isn’t that subsidizing a whole business sector? Maybe I’m misunderstanding something.
Which means that if you are in Year 1 of operation, your values for YearlyExpenses[-2:-5] are all 0 and you only get to deduct 1/5 of your actual operating costs for the year from your "profit". So you can be in the hole but still owe taxes on your "profit" for the year because what you spent money on was classified as R&D.
Why should money spent on software _development_ not have to be deprecated over time like other money spent on _development_?
I get that it sucks from a cash flow standpoint but the same is going to be true of other R&D expenses. It's just that we're more exposed to this specific R&D expenditure and not others.
> Originally enacted in 1954, Sec. 174 has historically allowed taxpayers to deduct SRE expenditures in the year incurred. Its original aim was to level the playing field for small businesses, those without dedicated research teams, that may be unable to deduct product development expenses under Sec. 162 because the costs were not ordinary and necessary expenses paid or incurred in carrying on a trade or business
Straight-up, any deviation in the tax code for a special group is always a subsidy.
Just to be clear, "special group" here means "any small business that wants to do any R&D of any kind", right? Because software was not a special group before, all R&D was opt-in for this kind of accounting.
Now, after this change, software is a special group singled out, a deviation in the tax code specially carved out for us to make our field specifically the exceptional one with no wiggle room. No other type of development is named in Section 174 to explicitly require companies to amortize.
Uh sure, with this change software would subsidize other R&D. Prior to the change anybody not eligible for Section 174 was subsidizing Section 174 recipients.
Subsidizing R&D is probably a good idea but let's call a spade a spade here. Additionally, subsidizing small business is good policy because they're by the numbers job creators while large businesses are job destroyers.
I mean, yes, it will be true for other R&D types. But that's also new and also broken for the same reason: it means new R&D companies are at a massive disadvantage in their first few years compared to the established players who have lots of expenses queued up to deduct. It's wealth redistribution from young startups to established players who have 5 years of past expenses to use in their favor, and that is going to be a very bad thing for the health and vibrancy of our economy.
And, as a sibling points out (and as I pointed out in a comment at the top level), software is in this regime singled out from all other possible R&D expenses, making it particularly vulnerable. A skilled accountant/lawyer can probably turn big chunks of other R&D expenses into something that doesn't fall under 174. No amount of skill can do that for software, because we're singled out.
Because you slinging a React component or Vibecoding a security pile requires no Technology Readiness Level assessment nor does it have development liability. Rather, what we call Software Development is more appropriately labeled Software Engineering.
Salaries in general (not just of software developers) are tax deductible in many countries. This is desirable because we do not want companies to be paying taxes on revenue.
In the US, unless you are a C Corp then you probably also pay taxes on net income of some form. C Corps have some different accounting, where dividends are double taxed unfortunately.
Small business owners are very impacted by the R&D schedule.
Businesses are taxed on profits, not revenue. Paying people to write code is an expense, so you'd normally deduct that expense (plus all your other expenses) from your revenue to arrive at an amount that should be taxed.
That's the rub. Is it an operational expense, like rent or a capital expense, like buying machinery?
It is sort of between the two in my view and is highly dependant on what the software engineer does each day.
Are they fixing a bug, helping a customer, refactoring? I think that is operational.
Are they building out a new feature? That is capital. But it is not quite like buying equipment because it adds no value to the books. So depreciation seems off.
But the same issue applies to other roles. Is a sales persons day trying to land a sale, or trying to develop the business.
It all comes down to "intangible assets" and whether you are making them.
I think it is easier to just say if you are paying someone to work then you can deduct. There must be better ways to claw it back.
The whole reason for most business to exist is to use operations (operational costs) as a lever to increase the growth and intangible value of the business.
The answer is that it's an operational experience when it's a salaried employee and a capital expense when it's a contractor. Like not in a theoretical sense, this is how it's classified right now.
It stems from the difference in treatment of capital gains and income. Either way it’s deductible, the difference being when it is deductible and how much tax is saved. Capital deductions are typically done later since they require a taxable event.
It’s a fudge to make projections look better to allow congress to pass a budget neutral reconciliation bill with the intent that congress would remove the fudge before the consequences triggered.
Governments in general are pushing for capital gains tax normalization where instead of requiring a taxation event the capital gains tax would be levied yearly. In such a scenario the only difference remaining would stem from the difference taxation rates.
> Governments in general are pushing for capital gains tax normalization where instead of requiring a taxation event the capital gains tax would be levied yearly.
> Because taxing unrealised gains are wealth taxes.
No, wealth taxes are a tax on retained wealth (a stock). Taxing unrealized gains is a tax on income (a flow), it just changes the point at which taxation attaches from a realization event to the actual gain.
Yes, you have. You have an asset of greater value which you can leverage in a number of ways without liquidating it and "realizing" the gains. That's a real gain, with real value.
> you could be taxed over and over again
Only if you make new unrealized gains.
> and if the stick drops or hits zero then what?
Then you have a negative unrealized gain, or, equivalently, an unrealized loss. If you are taxing unrealized gains instead of taxing gains when realized, then the natural assumption would be, just as is done with taxing gains at realization, that negative unrealized gains are either offset against current income or against future unrealized gains, and so effectively create (considered on their own) negative (current or future) taxes. The simplest form of this is to offset only against future gains, by the simple mechanism that when gains are recognized for tax purposes, they adjust the basis value of the asset, and when unrealized losses occur, they don't effect the basis value at all, so you don't have a taxable unrealized gain again until the market value exceeds the basis value established at the prior peak.
More complex versions would allow you to offset some or all of the unrealized loss from the prior basis value against current income of other forms, but the amount of that offset would reduce the basis value of the asset.
The unrealized value is notional, not actual. This is a very important distinction. The notional value is often not remotely realizable. In many cases, the realizable value can be a tiny fraction of the notional value.
Most laypeople grossly conflate notional and real value. Taxing notional value massively inflates the adverse impact of tax incidence on expected returns relative to people’s casual intuition based on the relative tax rates for realized and unrealized gains.
A tax on unrealized gains is in effect a way of laundering a steep tax rate so that it looks “small” and therefore reasonable to the unsophisticated.
No, its an actual thing, measurable by some mechanism. Otherwise, this would be a non-discussion, as taxing it would be impossible, not a possible thing that we can argue about the merits of.
> The notional value is often not remotely realizable.
Whether it is or is not immediately realizable is immaterial to the desirability of taxing it; it may be material to designing the forms of taxation that should be acceptable. E.g., if the difficulty of realizing the value is, across the tax base, likely to making collecting the tax in cash or equivalents difficult, it would argue for permitting a fallback option for the tax to be collected in-kind, e.g., by the taxing jurisdiction acquiring a proportional interest in the asset equal to the share of the value of the asset represented by the taxes not paid by other means.
> A tax on unrealized gains is in effect a way of laundering a steep tax rate so that it looks “small” and therefore reasonable to the unsophisticated.
If you allow carry forwarded losses, even just by the simple method of adjusting basis values, and include taxes on realized gains (and carry forward, offsetting against current income with perhaps a negative net, etc., for realized losses), then taxing unrealized gains is identical to taxing realized gains if the gains are eventually realized, but simply avoids the ability to find maneuvers to benefit from leveraging the value of the asset without paying taxes by avoiding realization. It doesn't make a "steep" tax rate look small, it makes the tax rate look like exactly what it actually is, unlike taxing only realized gains, which makes an effectively non-existent tax on capital gains look like something more, when people can benefit from assets without realizing the gains.
For many assets, like real estate, there are liquid markets with market prices. There are a number of US states that already tax based on real estate value, you can dispute the assessed value but that impacts other things like insured value.
Being difficult to assess value is a problem they’ll make you pay an accountant for and punish you if you get it wrong, it’s not going to stop them.
In the US, most recent studies of asset portfolios suggest that 60-70% of notional asset value has no liquid market. We already generate fictitious valuations for compliance purposes in many cases (e.g. 409A) that no one confuses with being representative of actual value. Tax policy based on overt fiction is bad policy.
Even in the case of real estate, a large amount of value is locked up in extremely non-liquid markets. You might get a vaguely representative market-clearing transaction once per decade, with high price volatility that makes it nearly impossible to predict what the next market clearing transaction will look like. I’ve owned assets in these types of non-liquid markets; differences in subjective valuations can vary by an order of magnitude and there is no evidence from the market to support any of those values.
If you only include extremely liquid markets for tax purposes in order to make valuations vaguely plausible, assets will be made non-liquid such that they are excluded from consideration. Ultimately this is why taxes on unrealized gains have been a challenging proposition in practice. We have no way to accurately model realizable value for the majority of assets and current simple approaches produce extremely wrong estimates a substantial percentage of the time.
They’ll make up a number and make you spend money proving otherwise. The government won’t care about your inconvenience when they need the money.
Of course this is a prediction of something that hasn’t happened before but looking at the chess prices move this does appear to be an intended destination.
That isn’t the asset valuation, that is the range of assessments interested parties make with respect to asset value. Because market clearing transactions are rare in many asset markets, those extremely high variance estimates of asset value are all you have to work with. It is only marginally better than no information at all. Too make matters worse, the rare transactions in these markets frequently have a lot of complicated structure such that the nominal price is not reflective of the underlying value.
tl;dr: Many assets have no meaningfully assessable fair market value. These are investments with extremely long and indefinite time horizons before the asset value can be assessed in a reasonable way. You can look at it as a peculiar type of risk capital portfolio with an extraordinarily long time horizon.
imo, it's in the best interest of the market for people to have to realize their gains otherwise the price of an item is pretty imaginary if it's never realized.
Gains are frequently not realizable as a matter of law and/or contract, for good reason. Additionally, there are many assets with notional value conditional on not liquidating them, which makes them de facto not realizable. And of course, the majority of assets have no liquidity, so realizability is a practical fiction.
The unrealized values are a fiction. There is significant value in treating values as unknowable when they are, in fact, unknowable. Forcing people to make up a fake valuation creates a lot of adverse incentives.
Then instead of taxing the gains, you'd accept the government nationalizing the assets by eminent domain and paying fair compensation that was significantly less than the "fictional" unrealized value?
Or if someone unlawfully deprived you of the asset, you'd accept as restitution or seek as civil damages for the loss something significantly less than the "fictional" value?
Or, when it was no longer an excuse to avoid fair taxation, would that "fiction" suddenly be a lot more real to you?
It would be much better to tax the benefits of the unrealized gain that a person realizes.
It’s much easier to do because there is no disputing the assessment since the person implicitly agrees to the valuation. And it allows people to forgo realizing any benefit from the unrealized value at all to avoid taxation.
Say take x% of the top of the money lent to someone who uses their unrealized gain to secure a loan. Make the money paid count against any tax they owe if they sell the asset later.
Have you taken out a secured loan in the last year over x amount?
Take the value of the asset assessed by the bank and the price paid for the asset to find the total value that is unrealized gain.
Divide that by the total value to get percent of collateral that is unrealized gain. Multiply that by the loan value. Then multiply that by the tax percentage.
All you need is for banks to report secured loans to the IRS and it’s easy.
But if those skyrocket in price from tax, they'll be more subtle about convincing banks they're good for the money and pay a slightly higher rate for unsecured loans.
Or maybe they'll just treat the asset securing the loan as having the pre-gains price. Get the bank to agree it's worth at least what you paid, with no further analysis.
If you try to plug those loopholes you lose the "much easier to do because there is no disputing the assessment since the person implicitly agrees to the valuation" factor.
>treat the asset securing the loan as having the pre-gains price
That’s no different than if the asset had no unrealized gain at all.
>they’ll be more subtle
It only takes a small rise in interest rates before it’s cheaper to pay the tax—assuming the tax isn’t outrageous.
Unsecured are much riskier because of the way unsecured creditors are treated in bankruptcy, so they already have higher interest rates.
It would be very easy to tweak bankruptcy laws to make unsecured loans over a certain amount a bit riskier to increase the delta even more.
We also already have regulations governing how banks assess creditworthiness, and the percent of their capital they can lend unsecured based on risk. As well as the amount of unsecured loans they can make to signal individual. If necessary tweak those values.
Another easy way is to add a surcharge to large unsecured loans where the loan amount exceeds the taxpayer’s assets based on acquisition price by some large margin.
None of those impact implicitly agreeing to the valuation and they are all pretty easy to do.
> That’s no different than if the asset had no unrealized gain at all.
It lets you get loans based on 100% of your pre-gain money with zero taxes paid, which I think is too generous. You wouldn't do that if it was actually all your money. It mostly fits the idea of only taxing the "used" money, but not entirely, and I don't really favor that idea in the first place.
> It only takes a small rise in interest rates before it’s cheaper to pay the tax—assuming the tax isn’t outrageous.
15% tax is pretty big. And if we put capital gains back in line with income tax it would be double that.
> Unsecured are much riskier because of the way unsecured creditors are treated in bankruptcy, so they already have higher interest rates.
If the unsecured loans only go up to 90% of the post-gain asset value, that's not much riskier, is it?
> We also already have regulations governing how banks assess creditworthiness, and the percent of their capital they can lend unsecured based on risk. As well as the amount of unsecured loans they can make to signal individual. If necessary tweak those values.
Yeah okay we could stop unsecured loans from happening. That seems awkward though.
> Another easy way is to add a surcharge to large unsecured loans where the loan amount exceeds the taxpayer’s assets based on acquisition price by some large margin.
>It lets you get loans based on 100% of your pre-gain money with zero taxes paid.
You already paid taxes on the money you used to buy the asset. You aren’t using any part of the unrealized gain.
>You wouldn’t do that if it was actually all your money.
People take out loans secured by assets that haven’t appreciated all the time, they even put up assets that haven’t appreciated depreciated as collateral.
>only to yo to 90% of the post—gain asset value
Unsecured creditors come last in bankruptcy. They routinely end up taking pennies on the dollar. That’s the extra risk of making an unsecured loan vs a secured loan and the reason interest rates on unsecured loans are generally somewhere around 20% higher.
It would be very easy to some tweaks to bankruptcy law to increase the difference.
>stop unsecured loans from happening
We don’t have to stop them, but I think stopping unsecured loans over some large value would be a lot less problematic than taxing unrealized gains.
>15% tax is pretty big
It shouldn’t be the same rate as capital gains. You’re not getting the same value as if you’d sold the asset because you have to pay back the money with interest.
Even at 15% you only need to get the delta between a secured and unsecured loan to 3 points before the additional interest costs more than the tax.
You are basically making my case for me. It is widely recognized that replacement value differs materially from notional value. In such cases you may be required to pay much more than notional value because you have to pay for liquidity costs that only exist when transactions are forced to occur. The act of transacting can intrinsically change the asset value, sometimes by a large factor.
Are you oblivious to the extensive litigation that occurs in cases like eminent domain because there are substantial differences of opinion on even the notional value, never mind the realizable value?
Notional valuations are fiction, everywhere and at all times. Treating them as some kind of objective reality is just enabling a lot of abuse and motivated reasoning.
If pegged to inflation then they are not, but I think they generally will not be pegged. People who might think this is great should understand that the government makes more money increasing wealth inequality aligning the interest of the government and the ultra rich.
So if company A pays company B to develop some software, that revenue for company B (or rather, its profit) is still taxable? Then it makes sense I guess.
No, you have it right. Software was getting a special exception from the normal rule that salaries spent on creating capitalized assets are capitalized (which is the general rule for most industries, as well as for software development in most of the EU).
