I've read a little about this, but not a lot. How has this put sufficient drag on starting a business that it's impractical to go from zero to one? Is there an aspect of the business model that's particularly impacted?
For mature companies, it all evens out, because you write off the costs over 5 years and it's just a blip. You can just borrow that money as a corporate bond, creating a real but manageable cost. For growing companies, it's forcing you to set aside money now (in the form of a tax deduction) you won't get back until year 5. So your burn rate is going up. And, unlike a mature company where the cost decreases over time (by year 5 it was a one time blip), that's only to the degree your salary costs have been stable for five years. Every time you scale up engineering staff, it puts you more in the hole for another five years.
For public companies, they are incentivized to amortize over longer period because it hides expenses and can boost earnings that boosts stock price.
If any property with respect to which specified research or experimental
expenditures are paid or incurred is disposed, retired, or abandoned
during the period during which such expenditures are allowed as an amortization
deduction under this section, no deduction shall be allowed with respect to
such expenditures on account of such disposition, retirement, or abandonment
and such amortization deduction shall continue with respect to such expenditures.But if the typical lifetime is 5 years, but you use an ADS of 2 years... you are not disposing or abandoning the asset if you keep it for 2 years. 2 years is the expected life time of the asset, and at the end of year 2, the asset has a value of $0.
If you depreciate over 5 years, but then on year 2 decide you don't need the asset anymore, then you'll dispose of it. The asset is valued at 3/5ths of the original price. The paragraph you're quoting applies to this scenario.
ADS doesn't apply here though, because TCJA requires 5 years for domestic and 15 years for foreign research.
This pdf has handy chart to determine how to determine software development should be treat for accounting purposes. Grant Thornton is the external auditor for many large companies.
ttps://www.grantthornton.com/content/dam/grantthornton/website/assets/content-page-files/audit/pdfs/2020/accounting-software-costs/accounting-software-costs.pdf
https://www.grantthornton.com/insights/alerts/tax/2023/flash...
This seems to contradict your statement that “all software development costs [are] to be treated as r&d,” but my experience is that you know what you’re talking about. What am I missing here?
For example, for a new feature: if you plan (SRE), design the interface (SRE), write the feature (SRE), run it through QA (SRE), and then discover a bug and correct it -- that's still SRE.
If you put the software into prod, then discover a bug, then fix it (without improving performance or adding any functionality), then it might not be SRE.
But if you sell software, and you sell or install a release to a customer, and they (or you, under a support contract) discover a bug and fix it... but then you include the fix in your next release, probably SRE.
Or, if you put the software into prod, discover it breaks with a large data set, and you fix it by improving the performance of that section of code, probably SRE.
The expenses falling under that provision aren't going to make a significant change to the impact of TCJA on software development.
(Disclaimer: not seeking tax advice or legal advice, we’re just two dudes casually discussing section 174 like normal people do all the time).
That notice was a helpful read. I think what I may have been missing was section 5 of Rev. Proc. 2000-50, whereunder non-SRE software dev was also afforded some similar protection. I’ll read that after work but I’d still love you to answer the foregoing.
Definitely ask your CPA though. I'm not an accountant.
Is there a good chance of recategorization pushing a very marginal business off the cliff? Sure--that Twitter thread, where there are enough details to read in, has a lot of examples of marginal businesses having trouble (mostly because of not being able to plan in the change, which really sucks). But you don't have that on day zero, and going in with the aim to be that very marginal business is probably not the best of ideas. It's not a day-zero problem, and I am struggling to see where a small business with a business plan that was previously worth executing on is now not worth it because of this change.
To slightly simplify: it forces startups to pay taxes on profits that only exist on paper, with cash that is now much more scarce
For a clearer picture on this it’s helpful to include the actual tax amount. With a corporate rate of 21%, the tax would be about $12K.
Now that’s not zero, but it better shows the actual cost born in year one under this plan.
The later years are important as well. As profits continue to flow in, the rest of the cost can be deducted from it. So it doesn’t disappear.
Though you do lose a bit from the nature of present nominal being inherently worth more than future nominal amount. With todays higher rates, that’s an even larger factor.
Affected small businesses suddenly need to increase revenue or cut costs by 20% just to keep their business solvent. Most small businesses do not have the structural elasticity or capital reserves to absorb that, nor do many business plans. In the very long term it notionally all evens out but most small businesses don't survive that long and these large new costs of doing business will reduce the survival rate even further.