Comment by chermi

Comment by chermi 8 days ago

Can someone steelman the positives for me? I don't see how it's anything but pure regulatory capture favoring established tech firms. A small company ramping up revenue simply can't handle this amortization while a large, established company can.

That being said, I do think there's a little sloppiness in what is categorized as "R&D" in the software development. Is code maintenance R&D? Bug fixes? Performance improvements? Is it a "capital asset" no longer under R&D once it hits production? This aspect has always seemed too gray given how much money is at stake in taxes.

But again, this complexity is an advantage for more established firms with legal departments and the infrastructure in place to document everything in order to handle audits. Which, in my view, is a form of regulatory capture; this presentation of symptoms of regulatory capture is pretty common.

One potential argument I can see is that maybe this balances out since presumably the more established firms would have less "R&D" as a fraction of expenses to deduct in the first place?

Edited to fix some typos and clarity.

floxy 8 days ago

Doesn't this kind of make sense if software is an asset? If your company purchases a seat of Oracle or Solidworks or Windows 11 or whatever. I don't think you can expense that all at one time, you have to amortize over the useful life of the software, just like if it was a physical printing press or a backhoe. Similar if you were making a software program for sale or for use internally, there is the upfront costs associated with making the software, and then it gets used/sold for the next X number of years. And software never wears out, unlike a tractor; that's at least why physical goods are amortized over a finite life. Probably the biggest problem is that this conceptualization of software might be 20 years out of date.

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jandrewrogers 8 days ago

The vast majority of software barely qualifies as an asset, since it has no intrinsic value. It isn’t like a tractor or a factory, which has a non-zero market-clearing price.
A one-off shell script has an asset value of zero after its single use but still counts as a long-term capital asset for tax purposes.

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chermi 8 days ago

Thanks, this is the closest thing to making sense. But it still doesn't make sense.
Like you said, this is a pretty weird characterization of software. I guess it would make sense to lawmakers who have no idea how it works. Combine that with the fact the lobbyists pushing this are 99% representing big tech and you start to get a picture of how this happens.
Warning- brain dump not directly related to topic, read at your own risk. Lol @ software never wearing out. I wonder how that works with something like Microsoft windows licenses(as opposed to something like 365 which has new "features" every year)? I'm actually asking, how do you amortize an "asset" that you are admitting only lasts a year? I know SaaS on consumer side is categorized as opex.
Does this capital-asset view of software have any effect on the attractiveness of SaaS going forward? I know we were talking about the development side of things not the consumption side, but it seems like this capital/asset perspective conflicts with the reality of how software is often sold. SaaS is partially justified as the cost of 'maintaining' the software (in addition to support and new features). The fact that maintenance is required belies the perspective that it's a capital asset. Coming full circle, this must require the vendor/developer demarcate programmer effort between feature vs. maintenance & support. If anyone has a sythensis of all of this or reference it would be appreciated

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- floxy 8 days ago
  
  >The fact that maintenance is required belies the perspective that it's a capital asset.
  I'm not following this. Factories, ships, stamping presses all require lots of maintenance and up keep.
  
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  chermi 8 days ago
  
  You're right. I was focused on the idea that for software to be taxed as a capital investment there had to be a time when it was considered a finished product. Like building a tractor. I guess the analogy then is how the tractor builder is taxed when fulfilling warranties. I suppose tractor business can expense as R&D work that goes into processes that make it easier to fulfill warranties.
  
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gnopgnip 8 days ago

Generally the US requires valuable assets to be depreciated and amortized over their useful life. This is arguably a fair way to tax businesses with fewer downsides than many alternatives.

Consider a different situation, a business pays employees to build a residential home for $275k total, the land is worth zero in this simple example. Currently they can deduct $10k a year for 27.5 years to depreciate the home, even though they paid $275k up front. Allowing the business to deduct the entire $275k at once, only recovering the difference when the depreciated asset is sold is basically a tax free loan at the expense of all other taxpayers.

To be fair there are many situations where the government wants to incentivize spending in certain areas. Certain types of businesses can avoid depreciation and deduct full expenses, like for farm equipment and heavy duty vehicles, previously most R&D. Or where accelerated or bonus depreciation is used because most of the income is in the first few years. Like a taxi follows a 5 year double depreciation schedule, in the first year a $25k taxi would depreciate $10k, then $6k the next year, there are many examples that are on a shorter schedule.

Keeping a 5 year straight line depreciation on R&D benefits large established businesses and burdens startups, this is primarily a political decision and not economic. Another issue is that not all R&D spending results in a valuable asset with a usable life

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andrewlgood 7 days ago

I think you are confusing the use case. If a business pays employees to build a residential home for $275k and the land cost $0, they don’t deduct anything. Assume they sell the home for $350k. They then have a cost of sale of $275k so they make a profit of $35k0 - 275k = $75k. They then pay tax on the $75 in the year the home was sold.
Section 174 relates to Research and Development expenses. The idea originally was they firms were spending a lot of money to develop a product that might have long useful life, but the expenses were all hitting the operating expense in the current year. This is great for cash tax purposes, but bad for metrics like operating income and net income which impact many firms valuations. Arguably it also misrepresents the firm’s business model. A fundamental idea is that costs should be reflected consistently with the period that revenue is earned. With R&D, the revenue is expected to be earned over many years but the costs are incurred upfront.
The better example is not a residential home, but an apartment building. The builder spends $300M to build the apartments then leases them for the next 30 years. In that example, the $300M is depreciated over 30 years so the costs track with the expenses.

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- gnopgnip 7 days ago
  
  Yes this is the same type of example. A builder that spends $300m to build apartments doesn't deduct $300m in the first year. The same way a real estate investor that builds a single family home to rent out doesn't deduct $275k the first year
  
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thinkindie 8 days ago

I believe that this is and similar example are missing a very important point in the narrative: in case of developing land to build a building, you will still have the possibility to deduct 100% of the salaries of the construction workers.
Those construction workers will build the building (= the product) on top of the land that you acquired (another asset) which means you are assets become the land itself and the building. Land and building will have their own asset value (purchase price or evaluation) that will be used for over X years.
As far as I understand as an European watching this from abroad, they are trying to evaluate the value of the asset (= code, the product) of a startup by using development costs as a proxy.

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- gnopgnip 7 days ago
  
  Employee salary is part of the capitalized cost and depreciated.
  Land value is generally not a deductible expense at all, and as such it is not depreciated. Some related costs like property tax, insurance, mortgage interest are deductible when paid though
  
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redler 8 days ago

The purpose, if you want to call it a positive, was to be one of many revenue increases designed to offset the cost of the income tax cuts that were the primary focus of that legislation.

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Analemma_ 8 days ago

> Can someone steelman the positives for me?

They’re literally aren’t any. Treating payroll expenses as depreciating assets is insane, and that’s why it isn’t done in any other context— not in the US or anywhere else in the world.

That sounds like a biased explanation, but it’s genuinely the truth: it was stuck in the Trump’s tax bill to help it evade budget balancing rules, but was designed to be so stupid that a future Congress would “surely” repeal it, after the TCJA had passed successfully. This sort of horse-trading happens all the time with budgets, but for whatever reason, this provision was never undone.

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