Comment by jsherwani

Comment by jsherwani 8 days ago

52 replies

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For folks that don't know the background on this, here's a layperson summary:

- A business is usually taxed on its profits: you deduct your revenue from the cost of producing that revenue, and the delta is what you are taxed on.

- In software businesses, this usually means if you spend $1M in software development to develop a web app, and it makes $1.1M in that year, you'd get taxed on the $100K profits.

- However, a few years ago, the IRS stopped allowing the $1M to be deducted in the year it was incurred. Instead, the $1M was to be amortized over 5 years, so now the business can only count $200K as the deductible expense for that year. So now it's going to be taxed on "profits" of $900K. Assuming the tax rate is 20%, that means the business owes $180K in taxes, even though it has a total of $100K in the bank after the actual expenses were paid. So it would have to either borrow to pay taxes or raise venture capital, meaning that VC-funded companies would be advantaged over bootstrapped ones!

- The letter's goal is to bring things back to how they were (and how they are for all other businesses): let businesses deduct their actual expenses from their actual revenue, and tax that actual profit.

I am neither a lawyer nor an accountant, this is just my understanding of this issue.

Edit: Switched the tax rate to 20%. The logic is still the same.

tossandthrow 8 days ago

While this does convey the idea, the premise is also biased.

> even though it has a total of $100K in the bank after the actual expenses were paid.

People running a business can perfectly understand the concept of liquidity. And yes, just because you transform money to something else, then it doesn't mean that you should not be taxed on it.

The extreme example is a company that buys gold on the last trading day of the year - now there is no profit! On the first day they sell the gold again and does tax eviction.

The core question is to what extend software constitutes an asset or consumption.

(Personally, I do not believe that software constitutes an asset in any meaningful way, but a practical tradeoff could be that software is a 10% asset)

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  • ashwinsundar 8 days ago

    I think you are conflating "software engineers" with "software". A business that pays a software engineer doesn't automatically receive working software in return, especially not in the first year. It doesn't seem fair to assume that paying a dev $200k means that the business received an asset (some code) worth $200k in return, and thus can be taxed on it as if it were an asset producing $200k in profits a year.

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    • tossandthrow 8 days ago

      I am not conflating, but the law is. Obviously it would be better to have an appraisal of the software - I reckon law makers see the cost of producing ad an ok proxy.

      Btw,this is how it is done in many construction projects also. Like bridges, budings, etc.

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      • ashwinsundar 8 days ago

        I don't know how you're supposed to value software. I just reread your original post - picking 10% out of thin air doesn't make much sense either.

        Software is more like a blueprint for a building, it's not the building itself. How much is a blueprint worth? If 100 architects spent a year on it, does that mean the blueprint is worth 100 x salaries? It might actually be worth nothing, if the blueprint asks the construction team to do something impossible.

        Software is even worse though, because at least with construction, there are known physical models and real-world constraints (like physics) that decide whether a design can or cannot be implemented. A piece of software written today might be entirely unimplementable and worth nothing, but a breakthrough elsewhere in 5 years might make it extremely valuable at that time

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        • tossandthrow 8 days ago

          I really agree in all your points, and the the 10% would be the proposed practical middle ground - but it is neither a good model.

          I don't know how to tax this.

          But I can identify the issue: You can channel your revenue into a non-taxible assets that you can bring into the next accounting period tax free.

          Regardless of this is stocks, bonds, gold, unsold inventory, or IP, that is not fair.

          I would hope for someone to device something that is fair and easy to understand. And then I would hope for them to get it through to the politicians.

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      • xlii 7 days ago

        Um, so you have it so that if I hire (let’s say) bridge engineer for 100$ but he doesn’t get any materials and produces only paper model which I sell for 1$ does it mean I’m going to be taxed based on 101$ ?

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        • tossandthrow 7 days ago

          andrewlgood is explaining the capitalization process in another thread under this post - I can recommend reading that.

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  • abeppu 8 days ago

    > The core question is to what extend software constitutes an asset or consumption.

    Isn't part of the problem with our industry that, even it is an asset, its value can be hard to determine even for a long time after you've written it, and it may be pretty weakly related to how much you paid to build it?

    - you might have spent a lot on developers last year but next year you find out that you're the new Quibi and no one wants to use your product

    - you might have had a small, tight team and what you built turns out to be hugely valuable (like instagram or whatsapp)

    - ... and to the degree that the software is part of a valuable business, how do you really assign value to the software as versus the go-to-market plan, the partnership/distribution agreements, etc that helped make the business succeed?

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    • tossandthrow 8 days ago

      These risks would appear to be the same as a shoe producer wanting to bring shoes to market - regardless they are still taxed on the value of their inventory.

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      • Dylan16807 7 days ago

        Some of the risks are similar, but your "regardless" is bypassing the point.

        We can value a real shoe pretty well. But what if we could duplicate all the shoes we built for less than a penny per pair? What would be the value of our inventory?

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      • [removed] 8 days ago
        [deleted]
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  • usefulcat 8 days ago

    > The extreme example is a company that buys gold on the last trading day of the year - now there is no profit! On the first day they sell the gold again and does tax eviction.

    In this example, it seems like you're assuming that the revenue from the sale of the gold would not be taxable, but I don't see why that should or would be the case.

    ETA: also, gold is far, far more fungible than any particular software

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  • teeray 8 days ago

    > The core question is to what extend software constitutes an asset

    Maybe we can finally deduct all that technical debt.

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    • ncruces 8 days ago

      If a software project fails can we claim depreciation, like after a car crash?

      Reply View 2 replies
      • tossandthrow 7 days ago

        Well, until now you automatically had depreciation.

        In the future you will still get it automatically, just deferred.

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        • ncruces 7 days ago

          You have the same, automatic deferral, with cars.

          But if you're in a crash, and it's a total loss, you can depreciate faster, which is helpful because you might need to buy a new one.

          So, since they're assets, can we write off software projects that fail?

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bryanlarsen 8 days ago

AFAICT, that $450K is refundable and transferable. IOW, if you make $0 in year two and have expenses of $0 in year two, you'd get a tax refund of $100K because $200K of your expenses from year one would be applied to year 2.

And it's transferable -- if your company fails, there are companies out there that will buy the rump of your company to realize the unrealized tax refunds.

Which is why it's usually fairly straightforward to get a factor loan to pay those $450K in taxes -- it's backed by an asset.

Factor loans are usually expensive with a high interest rate. Because you can get a factor loan, the taxes are not going to immediately bankrupt the company in the short term, but the high interest rates are going to hurt in the long term.

Not a lawyer nor an accountant. Not even an American.

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  • mediaman 8 days ago

    NOLs are generally not transferrable in the US (they used to be, but now the benefit can only be used if the acquirer of the 'rump' continues the existing operating business).

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zajio1am 8 days ago

> Assuming the tax rate is 50%

Which is not(?). According to https://en.wikipedia.org/wiki/Corporate_tax_in_the_United_St... , federal corporate income tax rate is 21%, + additional <10% for state level, not sure about local level.

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  • rbultje 7 days ago

    One of the reasons small businesses have been hit so hard with this is because for then (when incorporated as LLCs), their tax rate is 37% + state + local. I live in NYC and my LLC has a combined tax rate of 50%.

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    • throwanem 7 days ago

      You live in the most expensive metro in the country, one of the most expensive in the world, and tax is where you think your money problems come from?

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jll29 8 days ago

That's a great explanation, thanks a lot for sharing it.

Some big tech companies affected have laid off teams around the world, perhaps in order to mitigate the numbers looking bad to investors; so in a way, this adversely affected tech employees globally.

Every country should have such a rule for software businesses, which is an industry where all the cost has to be upfronted, so that bootstrapping is facilitated. There are plenty of smaller markets where the VC model is not the most appropriate funding instrument.

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hwillis 8 days ago

> a few years ago, the IRS stopped allowing the $1M to be deducted

It was Trump's 2017 Tax Cuts and Jobs Act, which amended IRS code.

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  • cjbgkagh 8 days ago

    It wasn't intended to stick, it's a bad idea that was intentionally bad in order to make it easier to reverse.

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    • rgbrgb 8 days ago

      I don't follow. What is the motivation of doing something intentionally bad to make it easy to reverse?

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      • elictronic 8 days ago

        Reducing taxes on businesses by 30%+ and high earners and the middle class by a smaller percentage. It’s a direct effect of the 2017 Republican tax reforms.

        If you want to pass something using only 50% of our representatives you have to pay for it with something else to balance the change. 60% of the vote and you don’t care what the Congressional budget office says. The primary software development hubs are not Republican leaning. The same reason SALT was changed. Voting matters.

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      • thaumasiotes 8 days ago

        The other responses have the right idea, but in more detail:

        All congressional bills receive an estimate of their budget impact over the next ten years. Whatever happens after ten years doesn't count.

        The politics are that a bill should have no budget impact within that ten-year window. As an uncharitable stylized example, you'd propose to start paying random subsidies to constituents immediately in the amount of $200M / year, forever. 8 years out, you also plan to raise taxes on somebody else, someone who would never vote for you in a million years, in the amount of $1B / year, which may or may not fade out after two years. This is a bill with no budget impact.

        It doesn't matter, to you, whether that spike in collections for years 9-10 actually happens or not. If you failed at targeting it exclusively to people you hate, you might prefer that it doesn't.

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        • rgbrgb 7 days ago

          ok, got it. So... this helped it pass because it allowed the headline to be "budget neutral" even though all signs point to this piece getting removed quickly and ultimately expanding the deficit. Sounds dishonest but logical if the objective is to reduce taxes without genuine consideration of the deficit. Thanks (to you and siblings) for the explanation.

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      • cjbgkagh 8 days ago

        The worse it was the better it worked as a budget fudge and it could be included in projections and allow a budget neutral bill to be passed. And by being so bad it would be easier to reverse as fewer people would defend it. There was an attempt to eat their cake and have it too.

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      • blks 8 days ago

        It was done to offset lowering other taxes

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    • [removed] 8 days ago
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  • gertlex 8 days ago

    > > a few years ago, the IRS stopped allowing the $1M to be deducted

    > It was Trump's 2017 Tax Cuts and Jobs Act, which amended IRS code.

    And took effect in 2022 (per what I've read elsewhere, and other comments on this post; could be off by a year)

    (just clarifying that the effect was "a few years ago", but I agree that it's important to know the origin of it, which you were pointing out)

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readthenotes1 8 days ago

Why do you assume a 50% tax rate in the United States when it is only 21%?

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  • quietbritishjim 8 days ago

    I think they meant "assume" like a mathematician, i.e., pretend it is this simple value to make all the calculations easier to understand.

    But it's still useful to know the real rate is 21%, thanks.

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  • jsherwani 8 days ago

    In California, the maximum personal income tax rate is effectively closer to 50%, which is where my mind went, but you're right, it's different for companies.

    In my example, the tax rate isn't the point though, it was used just to illustrate the math.

    The main point is that it makes no sense to require amortization of software development expenses. The idea that this letter is an attempt to restore rationality in the tax code.

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  • cjbgkagh 8 days ago

    State, city, property, social security tax, other fees and levies that should really be classified as taxes. The total tax burden can really add up.

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