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I am not a tax expert but my understanding is that a business would claim expenditure as R&D because of the beneficial tax treatment: it's a choice you make to categorise expenditure as R&D, you're under no obligation to do so. If the tax treatment of R&D spend has changed to be less favourable in your circumstance (i.e: you can't afford the short term cost of amortisation) then you would not claim the spend to be R&D related. After all, a small technology company working on their revenue-generating product is not doing anything experimental: it's only experimental if you massage it as such.

I could be far off the mark -- so please correct me if I am wrong -- but your framing suggests that if a business spends money on software development then they must amortise the cost which does not seem to be correct.

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This is how it worked in previous years. Previously, you could elect to take the R&E expenses either entirely in a single year or amortized over the longer period. This year the change is:

1) You can no longer take it all in the single year, and 2) All software development is now R&E automatically, no exceptions.

Note that this is separate from the R&E tax credit that you can also claim, that's a different deal in addition to this.

Reply from our CPA:

“There's pretty widespread bipartisan distaste for that change and there have been multiple attempts to extend the deadline or amend the change, but they haven't picked up steam yet. Still possible it will be changed retroactively. The saving grace is that a lot of the expenses they are talking about you needing to amortize would qualify for the R&D credits you'll be getting. So there's often a substantial offset between the two.”

This is what I've also heard from our CPA (that no one likes this and it shouldn't be happening), but since it's here and taxes are due in April, here we are.

You asked for advice and are ignoring it. ~~Don’t take the R&D credit.~~ Don't use Section 174. Problem solved.

EDIT:

Let me elaborate: unless you are in the “start up phase” incurring startup costs, you are not required to follow section 174. I suspect the confusion is between how we use “startup” colloquially vs how the IRC uses “startup costs”. Once your business is up and running you are “carrying on” business, even if you aren't yet making a profit. You are only required to follow section 174 if you are choosing to classify your expenses as “startup costs” which in my experience would be very odd after the first year and even after the business is founded.

Not an accountant of course, but nobody is going to tell me to pay taxes on revenue before expenses. And writing software does not automatically mean you are doing R&D. Not even in spirit. If you’re writing a script that speeds up part of your business and makes you more money, thats not “R&E”. It’s just work.

EDIT2:

> In the meantime, the Section 174 amendment should not cause established taxpayers to adjust their accounting methods when applying Section 162. Existing taxpayers incurring R&E costs as part of their ordinary and necessary expenses while carrying on a trade or business can continue to make deductions with confidence that legislative and judicial history support that practice.

https://news.bloombergtax.com/tax-insights-and-commentary/ch...

Again, I agree with everything you are saying in your edit. It's just not what my CPA is saying the actual tax code says anymore.

Honestly my main reason for starting this discussion was a) to see if anyone else's professional advice (e.g. from a CPA) was different, and b) to hopefully drum up awareness so maybe in some roundabout fashion this gets changed.

That's all fair. You're pretty persistently knocking down alternative interpretations as "not what my CPA said", though. Maybe just let them be and let people draw their own conclusions since this is a discussion. Idk. People are trying to help out and you just keep saying "not what my CPA said". Obviously we should be having this discussion with your CPA, then (:

If anyone knows of a CPA who thinks this isn't how it works now, please let me know their contact info, as I would love to pay them to advise me on this and get a third opinion.

You may want to consider consulting with an actual tax lawyer, not just a CPA. CPAs are not necessarily experts on all the implications of recent changes to tax law.

I don’t think your interpretation is correct. All R&E costs are now required to be capitalized. “Ordinary R&E” related to 162 doesn’t exist. If it’s any sort of R&E related expense, it’s technically supposed to be capitalized.

It really says a lot about the system when the people who pass laws bipartisanly are not happy about what they just passed. It's almost like they could have, I dunno, read and thought about what they were passing. Just imagine all the other BS slipping through.

The fact that there are unintended consequences in legislation does not mean no one read, or thought about it. These are thousands of Congressional staffers who read and study legislation, along with many more outside of Congress, but there are missed requirements, implementation bugs, and other problems in edge cases in legislation just like everything else, because the world is complex.

There's a difference between unintended consequences from something like an n-order affect on the system due to complexity vs a clearly written piece and uncomplex rule in the law. The latter suggests that due diligence was not performed. Of these thousands of staffers, it seems nobody bothered to read and understand it. We can look to history on how bills have been passed rapidly after introduction, without enough time to read and think about them. This makes me feel like the people in power don't really pay that much attention and don't care for careful deliberation.

Sure, bugs happen. But in a system that holds immense power over people's lives, we should be striving for the level of bugs to be similar to life critical safety systems and not some glitchy business website.

The bugs are a feature. Insane complexity in the tax code creates room for legal corruption through special favors that no one understands.

That's the bug.

I am a formal congressional staffer in both the House and the Senate and virtually no one reads any given bill or even cares much about what is in it other than memorizing the talking points about it. Bills are almost completely written by lobbyists and a bunch of 23 year old staffers are not knowledgeable enough to have any valid comprehension or input.

The job of a congressional staffer is to ensure reelection so we spend almost our time getting the member on the most powerful committees (for more campaign contributions) and getting on tv (for free media).

Committees do spend more time on the content of bills but each member usually only has one staffer for multiple committees and they are still told how to vote by the party.

This is true. I was a congressional staffer long ago, and before that I was an intern at the Legislative Digest, an official publication that summarizes legislation for the members of Congress. These summaries were often the only thing that members would read before they voted. If a member was really ambitious, he or she might read the committee report as well. But that's it.

I wasn't 23 years old when I was writing these summaries. I was 21. There was no one in the office over 30, and no lawyers.

https://en.wikipedia.org/wiki/Legislative_Digest

This is one reason why I think there should be a cap on the total volume of legislation (measured in pages). If you want to pass a new law, you need to repeal an old, obsolete one.

Nobody should be subject to a corpus of rules too volumous for them to read and understand.

It's absolutely unforgivable that legislators don't even read the laws they pass.

A version of this system was apparently implemented in Iceland - under the traditional law, once a year a designated person had to recite the entire law, and whatever he forgot to include was no longer the law.

There are 435 House members and 100 Senators. On any given bill they are not all going to have a role in shaping and negotiating it, and their staff will not have access to bill language as that is happening. Or perhaps even right up to the vote.

That does not imply that no one reads any bills. As a change to the tax code, the Section 174 language we’re all talking about was read by at minimum the (very capable) professional staff of the Joint Committee on Taxation and the CBO, for purposes of scoring the revenue impact of the bill.

The impacts of the Section 174 changes are in fact intentional, done to change said scoring. Whether or not they would be popular was not the point; all changes to the tax code are unpopular to someone. The point was to find a configuration of changes that could pass both houses at that time and get signed. That usually means a few big-ticket changes, and then lots of monkeying around with other things (like R&D) to offset those.

Just because they're not happy with it doesn't mean they had a better alternative.

It's easy to get a small change in when there's general agreement. But sometimes it's like immigration law --- few like the status quo, but there's no consensus on what direction to change it.

In general I agree. But in this case, their better alternative was the status quo prior to the change.

If it's the old status quo was that much better, it should be easy to get that one thing changed back. Legislation can be quick when enough people want it to be, and there's no mandatory business pending.

Can be. But small business don’t have lobbyist like the big businesses that likely dreamed this up and pushed it through to begin. They’re building moats, it’s what they do.

"It really says a lot about the system when the people who write code are not happy with the bugs they just wrote. It's almost like they could have, I dunno, read and thought about what they were writing. Just imagine all the other BS slipping through."

Just because you write, read, and understand anything doesn't mean mistakes don't get through. Should we never release any code unless it's completely bug free?

The 2017 TCJA was passed on pure party line votes (in the House, all Democrats and 12 Republicans opposed the bill), so it definitely wasn't bipartisan. More generally, big tax cut (the top 0.1% saw about $250K in lower taxes under the TCJA) and big spending bills jam in all sorts of random shenanigans to try and prove themselves revenue neutral, even though they almost never work out as described. One favored tactic, as we see here, is to kick big cans down the road and let a future Congress work out the problems. They (and this is one of those cases where both parties are equally complicit) know what they're doing, they just don't want to be honest about the fiscal implications of what they're doing.

Fixing these tax issues, on the other hand, would have had to be attached to the NDAA or omni last session, both of which require bipartisan support; big bipartisan bills are so contentious that it's hard to get unrelated deals through, especially since everything goes down to the wire these days. In this case, a deal that would have expanded child tax credits in exchange for a bunch of corporate and high net-worth household goodies, including section 174 fixes, was on the table, but couldn't get through negotiations. (I'll note that, while the Republicans created the section 174 mess in the first place, they are now trying to repeal that and other TCJA changes, but aren't willing to add lower-income individual tax cuts into the mix, which is what stalled things in the last Congress.)

It's a hell of a mess, and things are made crazier by the weird power dynamics in the current House leadership, where a small group of fiscal bomb-throwers have outsized power in the Republican party (and it's not clear that they care about tax minutiae, at least not while they're playing with a federal default on the national debt), but the inter-party margins are so slim that you could potentially cobble together a bipartisan majority on the edges. No one seems to like the section 174 situation, so it's at least theoretically possible that you could get a small coalition together to cut a deal at the last minute -- but I'm not sure we can count on that.

Wow, thank you for that detailed explanation. Very interesting.

There may be widespread bipartisan distaste, yet:

1. It passed in the 2017 tax changes

2. The Congress ending on Jan 3, 2023, did nothing about it, even though they totally could have

3. I think R&D credits will usually be significantly smaller compared to the salary paid

I’m an attorney who works with companies doing software dev everyday, and this is not only a really bad tax policy, but will be detrimental to US innovation. There are a few things you can do, as many others pointed out, like claiming the R&D credit (section 41), extending your tax return, and making sure you have sources of financing if you a owe a big tax bill.

My team also wrote an article on this subject a few weeks back with takeaways and graphs to show the potential math: https://capstantax.com/rev-proc-2023-11/

If anyone wants to reach out to me, feel free to do so as my contact info is at the bottom of the above article.

> it's a choice you make to categorise expenditure as R&D, you're under no obligation to do so

Link provided by author says there is no choice:

(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.

My understanding is that only applies if you're claiming that your expenditure is R&D, that is, it's saying that all software development costs are permitted as part of R&D not that if you spend money on software development you must declare it to be R&D.

There are other requirements to meet for expenditure to qualify as R&D, like experimentation and consideration of alternatives: if all software development is R&D and R&D must have alternatives considered and justified, are companies even permitted to engage in software development if suitable alternatives exist?

This is not what my accountant is telling me or what the articles I am finding from large accounting firms are saying...

It is not a choice anymore, if it is software dev, it's R&E now. They added a specific callout for software development only right to the tax code.

Example: if you are a restaurant and you buy an off the shelf point of sale software, this doesn't apply. If you are in the business of making a point of sale software to sell to restaurants, or your restaurant chain develops its own point of sale software internally, it applies to all costs related to the development of that software now.

Have you read this article: https://news.bloombergtax.com/tax-insights-and-commentary/ch...?

I haven't! I will forward that one to my accountant, thanks for pointing it out.

I am not sure the interpretation given in this article is correct. Specifically, this claim:

> "Is Section 174 Needed to Deduct R&E Expenses?"

> "In a word, no. During the Supreme Court oral arguments regarding Section 174, the IRS commissioner said that any ongoing business with a history of R&E expenditures could use Section 162, regardless of whether the new activities were in the same trade or business."

This article seems to gloss over the fact that Section 174 was essentially crossed out and rewritten in the TCJA. You can compare the previous version with the new version here: https://law.justia.com/codes/us/2020/title-26/subtitle-a/cha... (Compare the "Section Text" which applies pre-2022, to the amended version under "Editorial Notes" which takes effect in 2022.)

Court rulings and IRS commissioner statements which referred to the previous version of Section 174 may no longer be relevant. The previous version stated:

> "A taxpayer may treat research or experimental expenditures which are paid or incurred by him during the taxable year in connection with his trade or business as expenses which are not chargeable to capital account. The expenditures so treated shall be allowed as a deduction.".

Okay, if it says a taxpayer "may", that does not mean the taxpayer "must", and it makes sense that the alternative Section 162 deduction was still available for the same expense.

The new version states:

> "In the case of a taxpayer's specified research or experimental expenditures for any taxable year— (1) except as provided in paragraph (2), no deduction shall be allowed for such expenditures"

Paragraph (2) then describes the allowed amortization process. Note that any language suggesting this treatment is optional was removed in the new version. This suggests to me that Section 174 is now intended to supercede Section 162 when applied to research or experimental expenditures and therefore the Section 162 deduction may no longer be available.

I think your conclusion is correct. However, the more antecedent question is whether or not all expenses related to software development MUST be treated as R&E or not.

If that option exists still, then nobody needs to panic.

If it does not, then maybe everybody should panic.

Or at least, everybody starting up a business requiring in software development.

That is indeed the important question. Unfortunately we really need clarification from the IRS here (or additional action from Congress).

Spot on. This actually applies to most consultants like myself. Though I pay expenses in order to develop software, since I don't own the resulting IP I can't take advantage of the R&D credit.

Key verbiage here is "for purposes of this section". Section 174 can define software development expenses however it wants--that doesn't make amortization required.

> (a)(2)(B) be allowed an amortization deduction of such expenditures ratably over the 5-year period

I’m not familiar with this tax law, why would the “be allowed” verbiage here not mean it’s an election the taxpayer could choose to apply to their situation rather than a mandate as the OP is presenting it?

i.e. software development is always an R&E expenditure but you are only “allowed” (not “required”) to amortize it.

The problem is the one above that at the start of the section:

(1) except as provided in paragraph (2), no deduction shall be allowed for such expenditures, and

What that means is, you can't take it as a normal business expense deduction, except by following (2) which is to amortize it.

The question is who gets to decide that a given expenditure is an R&E expenditure. The way the law is written (even with the TCJA amendment) sounds to me as if the taxpayer makes this determination. Why would a taxpayer make such a determination? Presumably for the R&D credit.

I still do not see any clear indication that a taxpayer is required to consider any expenditures as R&E expenditures, though the new clause about software is ... troubling.

I think the key words there are "For purposes of this section", which means if you're choosing to designate it as R&E for the purpose of taking the deduction, you can do that with all software related expenses. The core premise of this post seems nonsensical, you're not going to be taxed on revenue as though it was profit.

Not in any way qualified to provide tax advice, don't take the above as anything but idle chat.

So how would someone categorize those expenses differently?

On a launched product, cost of sales. On an unlaunched product, cost of inventory, etc.

One of the key questions that defines "R&D" is technical risk: are you answering a question of "Can it be done?" or "How can we do it?" If you know how and you are just slapping it together, it's an opex.

"Software Use" rather than "Software Development"

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