Tell HN: Help restore the tax deduction for software dev in the US (Section 174)

Software engineering is not just about building new things. I'd propose that by far the majority of the time of software engineers is spent on maintenance, bug fixing, minor incremental improvements, etc. Almost all software is either sold directly as a service or as a product with a servicing agreement.

> most software development is creating an asset that pays off over time

This is a fantasy.

The tax code strives to minimize distortions (except insofar as they are deliberately introduced). That is, it seeks to minimize how much the existence of the income tax changes people’s economic conduct.

To minimize distortion, the income tax must accurately compute “income”—the actual increase in wealth. Depreciation is part of that. To compute income, the net increase in wealth, you need to subtract costs from revenue. When you buy an asset, your wealth doesn’t immediately increase or decrease—it simply changes form (from cash to an asset). The actual cost is the depreciation on the asset, which occurs over time.

Say you buy a delivery vehicle for $50,000. In the first year, you make $100,000 in revenue and have $20,000 in operating expenses. What’s your income after one year—the actual change in wealth? You have $80,000 in cash after operating expenses, plus a vehicle that you can sell for maybe $40,000. So you have $100,000+$40,000 in cash and assets in minus $20,000+$50,000 in cash and assets out, for a $70,000 increase in wealth.

Calculated another way, you have $100,000 in revenue-$20,000 in operating expenses-$10,000 in depreciation = $70,000 in income. Now, over say 5 years, you’ll depreciate the full $50,000 cost, and the total dollar amount the IRS gets will be the same. But it will get more taxes in the first year, which due to the time value of money is worth more than getting the money in subsequent years.

Capitalized means it’s treated as an investment into an asset rather than just a cost of doing business. The reason we do this is because we want revenue and expenses to reasonably match the time period where their value comes into play.

For example, if you build 100 widgets for $1M this year, the labor and materials cost of those widgets are capitalized into inventory. Next year you sell them all for $2M.

Capitalization rules would say you had no profit or loss in the first year, and $1M profit in the second year because the cost of the inventory gets expensed when the inventory is sold.

Fixed assets like buildings, machinery, and now software have pre defined lifetimes that the expense is realized over. In the case of software, it’s 5 years.

Tech companies don’t like this because they want to front load recognition of expenses to pay less taxes today.

Salary for building assets generally are capitalizable. Construction companies have a special carve out because they typically are hired to build the assets for someone else and are paid for the completion of the construction work.

A factory worker building a product to be sold is capitalized into inventory

Is 3 years reasonable?

If we are making say, a point-of-sale software rolled out in a fast food franchise (let’s take Chick-fil-A since they have edge Kubernetes deployments), is it reasonable that we won’t add features to that software in 3 years? Perhaps.

What about bug fixes? Is that expense or should we expect time spent on bug fixes to also be depreciated in 3 years?

What about configuration? Does configuring that POS for new menu items count as software development, and therefore needs to be depreciated over the next 3 years?

Chick-fil-A has edge Kubernetes. Does the install and implementation itself counts as “R&D”? If we argue that configuration can be expensed, then would writing manifests be depreciable or not? What if we use “infrastucture as code” tools such as Chef?

What about say, excel sheets and macros? Or forget macros — just basic use of a spreadsheet. Some manager add in a summation to a column to compute totals. Very basic stuff. Is that software development? If it is, would that be depreciated over 3-years?

If we argue that this is normal use of excel and should not be depreciated, then why wouldn’t my normal use of a compiler and editor also count as normal use and should not be depreciated?

Whether it is 5 years or 3 years, the point is that unlike physical capital goods, software changes very fast, even if the underlying hardware wasn’t changing that fast. It is not always that expert designers build them — software can also be written in a way where end users modify them. We also use software to make software, and can rapidly change our tooling in a way that we cannot with physical capital equipment.

I see the merit in categorizing software as capital, from an economic theory point of view, but software also has its own dynamic that is distinct from physical capital equipment. A tax code that does not acknowledge that can bring more overall harms to the society.