Thousands of small businesses are struggling because of R&D amortization

I have said this before and attracted downvotes for it, but here goes.

There are two possible arguments here to try, and I have only ever seen people lobbying against this change use the one, less persuasive argument. That argument is what I will call the "incentives" argument: that change in the rule provides bad incentives against doing R&D. This argument goes along the lines of "this will cost jobs for R&D workers" or "this will reduce the competitiveness of the US." The other possible argument (that I have not seen cited) is that "R&D" work can be operational, and that forcing capitalization of R&D expenses is a bad accounting practice. This Twitter thread only argues the former.

The glaring problem with the incentives argument is that it gives up the point that the ability to operationalize R&D work is a subsidy for technology and software companies. This is equivalent to asking for a subsidy at a time when startups can pull $100 million with no product and other technology companies are reaping record profits. That is not a particularly persuasive argument, and it triggers bad emotional reactions from people. If not for the SBIR companies getting absolutely shafted, the responses to this argument I have seen from non-tech people range from "fuck you" to "deal with it."

The accounting argument is boring and sort of technical, but also a lot harder to argue against and doesn't trigger a negative emotional reaction. All of the people making the rules will understand it, and the IRS could even make the clarification on what is and isn't "R&D" on an accounting basis without an act of congress. They have kind of done this, but have not been pushed nearly far enough.

As far as I understand it, it’s normal to deduct most all kinds of payroll as an operating expense, and historically that’s included software developers too. The way it was explained to me, the tax man gets his bite when the people receiving the paychecks pay their own income taxes.

The recent changes mean you can still do that for most staff EXCEPT developers, even if the devs are doing operational work instead of work that feels more conventionally like R&D. So you have to come up with a bundle of cash now to pay tax on most of the developers’ salaries, even though they’ll give it back to you over 5-15 years.

Essentially you making a free loan to the government for a decade or whatever, except the money’s probably not free to you.

Of course I can think of situations where the development effort really was more R&D than operational, and the revenue stream matched: the first few years operated at a loss already, and the deductions might have more been useful in 5 years when the revenues were flowing in from a mature product. But I think they might have ways to carry forward losses to future tax years or something to deal with situations like that?

It's not an "obvious loophole". They are quite specific about this. New features, new capabilities: R&D, must be amortized. Bug fixes for existing features: expensable.

The gray zone comes when a bug fix actually provides a new feature (e.g. something that wasn't actually usable before).

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).

Your CPA is not correct.

Any software development costs related to improving the product by providing new features must be amortized. Only clear bug fixes can have costs that are expensable.

This is made extremely clear in the IRS guidance document.