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Comment by BenFranklin100 | Hacker News Reader

This is going to wipe out a lot of small businesses, including innovative software dev startups.

Here’s a simplified example of this works: Let’s say you’re a four person software dev startup. Everybody is making, say, $125K to get by. That’s $500K in salary expense which normally you can write off as expenses against revenue/funding. For this example, let’s say somehow you also generated $500K in revenue/funding, i.e. you just broke even.

Currently, you would (of course) owe zero taxes. Under the new tax rules, you couldn’t write off those R&D salaries as expenses, only amortize them over 5 years. That is, your salary expenses for this year is only ~ $100K, and this you made a $400K ‘profit’ (!!) on which you owe taxes ($100K).

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I don't get it. How is this not just $500k salary? How is it R&D?

under the new regs, software work is required to be classified as R&D.

The idea is: You can hire a R&D team for one year, fire the entire R&D team and still benefits from their works in the next few years.

In terms of tax, should we average out these expense over the years?

These can have huge difference because how complex our tax and accounting rules are.

Further, R&D is at best a bet, as any of us who has ran a technology business well know. It’s not at all clear one will be able to take the research to market and monetize the R&D investment. Doing that is called founding a successful company.

And if the investment pays off, so that the R&D creates revenue in future years after it's already been paid for, then it will result in actual taxable profit in those future years.

It seems like the IRS is trying to speculatively tax unrealized future profits here, and that's pretty unconscionable.

Excellent point.

I would clarify here that it’s Congress that is doing the taxing. IRS is just implementing what they asked them to.

This is exactly what they are doing. If this scheme sticks, it will reduce R&D investment. It certainly disincentivizes me from investing in such efforts.

We once started a revolution over unfair taxation. I sadly think the same will be necessary to fix the status quo, as system has rotted past the point of meaningful reform.

Allowing the federal government to implement an income tax was one of the most destructive changes to the constitution we've ever made, and it's only gotten worse and worse over the decades. What was originally just supposed to be another tool to generate revenue has become an end in itself at best, an a lever to manipulate society at worst.

On top of that, the necessity of shoehorning everyone's economic activity into prescriptive taxonomies in order to implement this taxation has drastically diminished innovation on the margin, and has created unintended consequences that significantly distort market incentives and diminish our ability to adapt to change, with the situation we're discussing here being a prime example.

I'm worried that you're right; that it's beyond repair, and that we may have to live through a systemic collapse before things can get better.

It is salary, but it goes not into operational expense (that applies directly creating the things you sell right away) but into building a capital asset that helps you generate future revenue and can depreciate over a number of years.

It's just as if you pay the salaries of some construction workers to build you a new factory - those salaries are part of the capital investment for creating that factory (and depreciated as that asset), not your operating expenses.

I'm not familiar with US accounting laws, but why not just move R&D teams to operational roles, and have them do the very same work there?

As a SMB, if your salary expense is $500k and your revenue is $500k, you are absolutely struggling, no matter the tax situation. In this case you "just" need another $100k in revenue. After all, you are throwing out theoretical revenue numbers anyway. So it just moves the needle somewhat for you to still break even. You could game it just a little if there's revenue at end of year that you can book in the following quarter instead -- companies do the reverse of this all the time. Perhaps you can shift some of the expenses as well.

Note that in year 2, you get 20% of the year 2 salary expense, plus 20% from year 1. So the impact is less. By year 5 you are "caught up".

Indeed the first years are harder.

Companies don’t do “this all the time”. In your hypothetical example, you”d have to essentially forge the quarterly 941 reports to shift the salary R&D expenses. Also ‘gaming’ which quarter revenue occurred is technically tax fraud, certainly if one is on an accrual basis. And it doesn’t mean one is ‘caught up’ by year five. Any time a company increases R&D expenditures, it will have an impact.

Have you never bought anything? There is always a push at end of quarter and end of fiscal year, to sign the agreement NOW. so that it can be booked in that quarter. even though delivery won't happen until next ...

incentivized by quota but the incentive is there to get it on the books.

there is no forgery involved.

Yes, of course as you increase spend you increase the impact (in the year that you actually spent), but the context here is specifically very early SMBs, and more so, ones that would only be running break even under previous rules.

This is wrong because you are speaking on an accrual basis but you have to consider cash. The cash (salaries and taxes) is paid out in year 1 regardless of what year you try to book it in your p&l statements

i'm suggesting that as an early startup, in year 1 where this has the most impact (you aren't now bringing in previous years expense), your employees may be flexible enough that you pay out the cash 31 days delayed (example) instead of paying anything in December.

obviously if you pay salary in December, you paid in December and you have to book it that way.

I think you're arguing against the wrong point.

It doesn't matter if $500k/$500k is good or bad. They're only numbers that simplify the point without misrepresenting the situation.

I think I am being fair. The numbers $500k/$500k were picked arbitrarily to demonstrate how it would kill a business. If you were at $500k/$400k you would be similarly dead. "back then", $500k/$500k was enough to stay afloat. Now you "just" need to be at $500k/$600k, that's all. ie, your revenue needs to be somewhat higher (20% I guess? too lazy to math it) to pay the taxes. Assuming the business stays afloat, you'll eventually break even on the taxes, it's not forever lost like paying AMT for stock options that never become liquid, or RSUs that go well underwater before a lockup expires.

It does suck that a quirk in accounting means you were profitable on the books, no question there. But it "just" means you can't run so close to the bone. I don't think it's the world ender everyone is making it out to be. It means you need more operating capital up front.

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