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PaperclipPerfector  3mo ago (text post)   3832 thread views

Small-Scale Question Sunday for August 18, 2024

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One thing no one has mentioned yet...

As an unintended consequence of the Trump tax cuts, there was a change in how software developments salaries must be expensed. Before, the entire value of a software dev's salary could be written off immediately. Now, the salary must be amortized over 5 years.

So, let's say you start a software company. Your first year, you pay $1 million in salaries and sell $500,000 in licenses. Not only did you lose $500,000 in cash but you have a paper "profit" of $300,000 which you now must pay taxes on.

This heavily penalizes startups and makes software devs just less valuable generally. In some ways though, it levels the playing field with brick and mortar businesses who often face similarly outrageous taxes on phantom profits.

Everyone expected this to be fixed by now as it was an unintended consequence. But the Democrats love taxes and control the government so we appear to be stuck with it for now.

That's actually really interesting, is there a name for the loophole?

I don't think so, this is all new since last year.

It's not really a loophole since the government is taxing profits that don't exist. What's the opposite of a loophole? A gotcha, perhaps?

"Section 174"

https://blog.pragmaticengineer.com/section-174/

I'm not entirely convinced that this is inappropriate. If you pay $1 million as a one time investment to develop a software, and then sell $500,000 in licenses every year for five years, you get a profit of 2.5 - 1 = 1.5 million. Over five years that's 300,000 profit per year. Similar to if a factory bought 5 years worth of materials up front for $1 million and then spent five years producing and selling stuff for $500,000 per year. I assume that's the logic behind this regulation. Now I understand it's not realistic for a startup company to have literally no costs during that five year period, presumably they'd be doing tech support and adding new features and whatnot, but it's probably less than what their initial costs.

Further, shouldn't this actually help them pay less taxes in the long run? Unless I'm misunderstanding how corporate taxes work (which is very possible) a corporation that reports a $500k loss followed by 4 years of 500k gain is going to pay taxes on 2 mil, while a corporation with amortized costs that reports five years of 300k profit is going to pay taxes on 1.5 mil (their actual profits).

I get that it'll hurt more the first year. And if a company does actually have constant software costs every year then this will hurt the first few years before the amortization has a chance to reach equilibrium. But for companies that invest in software inconsistently as upgrades it makes sense to treat them the same way as any other infrastructure investment, which I believe are similarly amortized.

Similar to if a factory bought 5 years worth of materials up front for $1 million and then spent five years producing and selling stuff for $500,000 per year.

Yes, the new regulations put software on the same footing as brick and mortar. It's extremely painful for brick and mortar too since it penalizes any capital investment. This is likely a contributing factor to why no one builds anything any more.

Further, shouldn't this actually help them pay less taxes in the long run? ... a corporation that reports a $500k loss followed by 4 years of 500k gain is going to pay taxes on 2 mil.

No. They will pay tax on 1.5 million. Losses offset future gains for tax purposes.

And if a company does actually have constant software costs every year then this will hurt the first few years before the amortization has a chance to reach equilibrium.

Exactly. This rewards incumbents at the expense of startups. It's bad for that reason alone.

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