Amortization of R&D in tax returns

[ctilly]

R&D can no longer be deducted as a normal business expense but must be amortized across 5-15 years. This is due to a rewrite of "Section 174" which requires—starting in tax year 2022—this treatment. My CPA is completely clueless on this. This is really hard on small software companies as developer salaries now have to be deducted across multiple years, instead of immediately.

I'm curious what other folks are doing about this, if anything?!

 

[ab24]

@ctilly This is shocking. How can the IRS make the distinction between a salary for R&D and a regular developer salary? I didn’t even know employees were classified on tax returns other than contractors and employees.

 

[613jono]

@ab24 The distinction is the r&d tax credit. You want the credit? You have to amtz. It's still in your best interest to amortize and take the credit.

 

[ctilly]

@613jono You're wrong. All software development is now R&D under Section 174 and must be amortized. There's no option to NOT amortize software dev (and all the large firms have more or less confirmed this, but there may be some wiggle room for, e.g., QA). Credits are separately determined under Section 41. All Section 41 is Section 174; but the inverse is not true.

https://www.irs.gov/businesses/audi...x-credit-irc-41-qualified-research-activities

> Since section 41 is more restrictive than section 174, expenses allowable under section 174 will still have to meet the other requirements of section 41(b) and (d) to be a QRE.

View the pie chart here.

 

[613jono]

@ctilly I never said there was another option. I'm saying a huge push to stay compliant is to take the R&D credit. It seems like you know enough, so why ask what others are doing? There is clearly no option.

 

[ctilly]

@ab24 ALL software development is now officially classified as R&D. It's now explicitly in the law. Look at 174.c.3 here https://www.law.cornell.edu/uscode/text/26/174

 

[yonniejoy]

@ctilly Doesn't the way that paragraph read limit the scope of software development to just if you are seeking the R&D credit? What if you are a software company just building and maintaining your platform and not seeking to take the R&D credit?

 

[melody7]

@ctilly What was the reasoning behind this tax change I wonder?

 

[ctilly]

@melody7 They did it to reduce the revenue impact in the 2017 tax bill. It was always assumed that this portion would be repealed... but it hasn't been. There's a good article on it here: https://www.wsj.com/articles/small-...bills-from-research-deduction-change-a189b113

 

[beyoutifuloutlaw]

@ctilly I am so pissed about this. We are a small business and spend about 9% of our revenue on new product development/R&D every year to stay relevant. We also design hardware and develop software and make these on our own manufacturing lines in the US. We lost the domestic production activities deduction in the 2017 tax bill, pay tariffs on parts we cannot source anywhere other than China. And now this whammy that just inflated our taxable income by $1.4MM. WTF. Buy American my a$$. Nobody gives a sh*t about American innovation developed by any businesses other than the behemoths. And they damn sure don’t want us to manufacture here.

 

[gwenyth]

@beyoutifuloutlaw Really hoping this gets repealed retroactively, hugely impactful for cashflow in small/medium business.

 

[613jono]

@ctilly I am amortizing it over 5 years. First year is midpoint and last year is midpoint.

 

[ctilly]

@613jono Yeah... that's pretty brutal though! Was going to hire another developer, but hard to do when I can only deduct 10% of their salary in the first year!

 

[galatea]

@613jono is that effectively 100% total by

- Year 1 = 10%

- Year 2 = 20%

- Year 3 = 20%

- Year 4 = 20%

- Year 5 = 20%

- Year 6 = 10%

OR effectively 80% total by

- Year 1 = 10%

- Year 2 = 20%

- Year 3 = 20%

- Year 4 = 20%

- Year 5 = 10%

 

[613jono]

@galatea 1st option

 

[613jono]

@ctilly This is actually something I wrote about for a team once. The issue comes in on cash flow and paper profits. You should search R&d amortization and cash flow issues for more about it. Plenty of white papers on it from large firms.

 

[kash]

@ctilly Yeah, my tax burden this year is multiples of my net income. Like, 5x my net. All hiring is suspended (we planned to add 2 this year) and we are deliberately doing less R&D activity to lower next year's bill. We filed an extension and made a partial payment, but I'm not sure where the money is supposed to come from.

 

[gwenyth]

@kash In a similar position, has anything changed for you/your perspective since this post 3 months ago?

 

[kash]

@gwenyth No, nothing has changed except him a lot less hopeful that it gets fixed before the end of the year. All of my federal representatives are cosponsors on the bill, so it’s really frustrating that there’s nothing else I can do.