Startup founders read this... https://blog.pragmaticengineer.com/section-174/
WTF Is Going On? 🇺🇸WTF Is Going On? 🇺🇸
Many US software businesses amassed surprisingly high tax bills in 2023, seemingly out of nowhere, due to a tax change which took effect in July the previous year, which many small companies knew nothing about until finalizing their 2022 returns.
The change was expected to be repealed (reversed) in December 2022, so many accountants didn’t inform customers for that reason. So, businesses got a surprise when the first tax payments fell due last April.
The amendment to Section 174 means employing software engineers can no longer be accounted as a direct cost in the year they are paid – unlike the norm, globally.
Example Company 💻Example Company 💻
- A software company generates $1,000,000 of revenue per year running a SaaS service. It employs five engineers, and pays each $200,000. That is $1,000,000 paid in labor costs. $0 profit.
- In 2021, the answer would be zero profit. ✅
- In 2022, the answer was $900,000 in profits(!!) ❌ This is because from 2022, software engineer labor costs must be amortized over five years.
https://blog.pragmaticengineer.com/content/images/size/w1600/2024/01/Screenshot-2024-01-04-at-21.17.27.png
Knock-On Effects ⤵️Knock-On Effects ⤵️
What happens to a small, bootstrapped company without $189,000 in cash floating around with which to pay this tax?
- Take out a loan at a relatively high interest rate (likely at around 10%+)
- Lay off a software engineer on $200,000 per year and use this saving to pay the bill!
Other Implications:
- Less hiring of software engineers in the US/more layoffs 👎
- Firing of non-US software engineers employed by US companies 👎
- A boon for purchasing SaaS companies and vendors (mergers & acquisitions) 👍
- It makes a lot less sense to incorporate tech startups in the US 👎
- Startup software IP will likely be moved out of the US 👎
- Tech companies are now forced to understand – and use – R&D credits 👎
- Innovation across all US software companies will take a hit if Section 174 stays 👎
- Thanks to the Section 174 amendment, starting a tech company outside the US is far more attractive now – including for raising startup capital 👍
Good for other countries. This is what we need more of - bad laws to contrast with jurisdictions where the laws are not as bad, so people can see what works better.
Indeed. The thesis from The Sovereign Individual (written in 1996) is a useful reference, which I have stolen from @blocktock's summary here on SN:
This is absolutely ridiculous. It's not a solution, and I'm certainly not advocating this, but you may see some "creative" job descriptions ameliorating this issue. I have worked in various industries where capital improvements magically turned into ordinary expenses come the end of the year. This seems analogous.
We may see a massive shift to 'contractor' work too. People fired but then re-employed as a non-employee on higher day/hourly rates, but with fewer rights/benefits to circumvent the tax.
And/or U.S. companies looking more to Argentina, Colombia, Philippines - where talent is available at a fraction of the cost. Definitely "squeeky-bum" time though, if the guidance stays as-is.
Yes. In fact that's a better solution than what I metioned. There will be workarounds, but it's still emblematic of the U.S. turning away from paying lip service to a business friendly, free market economy and fully embracing socialism.
Egyptian devs are actually my fav:)
Guys, working with people from other time zones earns you extra time too! Imagine when you are sleeping, others doing the work, and then when you wake up, things are done:)!
It certainly works well for me.
Can be challenging when you have a 12 hour inversion of time zones though, as you very rarely get any face to face time with your team.
After finishing your day too, you need to line-up theirs & make sure you “pass the baton on”, which can lead to staying later. But the benefits drastically outweigh the drawbacks.
curious why these companies don't register their companies in other jurisdictions? I mean, shouldn't tech companies be borderless and remote-compatible?
Bingo!
Seems to me, despite the pool of talent, exclusively basing your business from the U.S. may be a huge liability from here on out. Especially when you could likely recruit U.S. engineers from afar. The IRS is actively torching their 'golden goose', if this doesn't get unwound. I guess those 85,000 agents need to do something to fill their miserable days.
Yay, another thing to add to the discussuion in #370129
Great post and question 👏 will get involved in the discussion
I know little about this, was just wondering how this works currently in other industries. Say, if I was running a company that was a physical hardware version of what this software company provides, i.e, I employed five hardware and electrical engineers who perform maintenance and installations of electrical hardware, would I still be subject to the same amendment?
Sounds very undemocratic.
It's specifically targeted at 'Software Development', so they wouldn't be captured under this new tax law. My take is that the country might be serious about pivoting to bring back manufacturing, so I think that type of business will get various incentives or fewer disincentives at least for the foreseeable future.
Hmm that doesn't seem like good incentives here for the US, either you get your engineers to automate as much as they can and keep them on as freelancers, spin up your tech division in another country, use freelancers from around the world or just set up offshore completely but serve the US market
I guess they see tech as an avenue for some taxes but this doesn't seem like its going to generate much and just reduce the tax base. oh well
As a software engineer in the US with hopes to start a business… yikes. Where do you suggest going? I see Uruguay in the comments. Anyone else want to give their 2 sats?
P.S. Come to Uruguay 🇺🇾 cowboy & cowgirl founders. Read this SN post again on what it offers 🤠
It's on my list :)
The best thing to do with the US would be to switch it off and on again but then install linux instead of this corporate crap.
If you can find the off switch, please let us all know.
Yes it's called #BTC
paying down tech debt is now a capex investment 😂
Eek 😬