This US tax change could kill your business (and it already took effect!)

Taxes aren't the most exciting topic, but there's a tax change in the US that came into effect for 2022 that you need to be aware of. It could drastically increase your tax bill for this year, even if you aren't profitable.

All software development costs—from building new software to adding new features to existing products—can no longer be written off as an expense but instead have to be amortized (that is, spread out over 5-15 years).

This is because of changes to Section 174 of the US tax code, which categorize all software development as "research and experimental." For the past 70 years, companies have had the option to expense (write-off in their entirety) or amortize (spread out) these costs, but now, we must amortize.

(This applies even if a company doesn't think they do R&D and doesn't apply for R&D tax credits. It's confusing, but R&E is different from R&D.)

This is causing founders' tax bills to skyrocket. It is not a hypothetical problem, it is not a potential bill. People are already getting these higher tax bills. It is real, it is happening, and it is threatening to bankrupt indie SaaS founders across the US.

This applies even if your business isn't making money yet. If you incorporated but haven't launched yet, all of the costs you've incurred would normally be write-offs. Now, you can only deduct a small portion of them per year.

You've probably heard about this recently on Startups for the Rest of Us, Build Your SaaS, Software Social and Arvid & Tyler Catch Up. It was also covered in the Wall Street Journal and Technical.ly

Examples of Section 174 impact on small software businesses

These examples use simplified math on purpose. If you want to get more details, see my tweet thread on this that was fact-checked by tax experts before posting. I'll post explanations of the math used here in the comments.

Let's say someone started their side project on January 1, 2022 and launched it before the end of the year, and ended the year with $2,000 in revenue. They incurred $1,000 to build it before launch, $500 related to building new features after launch, and $500 on marketing costs.

Previously, 100% of those $2,000 in costs would all be write-offs, and their net taxable income would be $0.

Now, only a portion of the product development and feature development costs can be deducted per year. This change increases their net income from $0 to $1,350, which they now need to pay tax on. If we assume a 25% tax rate, that's a $337 tax bill on a business that didn't make any money.

You can see how this quickly spirals with a larger company. Imagine a more established indie SaaS that made $1M in revenue last year, spent $700,000 on developer salaries and $200,000 on other expenses. Ordinarily, they'd be able to write off $900,000 and have a taxable net income of $100,000. Assuming a tax rate of 25% that's a $25,000 tax bill.

Now, if you assume developers spent 50% of their time building new products and new features, and 50% of other expenses were on new features, only $420,000 of the salary costs and $110,000 of other expenses are write-offs. Their taxable income just went from $100,000 to $470,000. Assuming a 25% tax rate, their tax bill is now $117,500 — which exceeds their actual net income.

As a result of these tax bills that are exceeding people's real profit, people are freezing hiring, considering layoffs, using credit cards to pay the tax bill, and taking out loans of credit. It is a serious crisis.

This is insane. What can we do about it?

I'm glad you asked!

The absolutely unbelievable part about all of this is that Congress never intended for this change to take effect. It was basically an accounting trick to pay for the 2017 tax cuts, but they always planned to repeal it before it took effect.

Congress, with widespread and bipartisan support, tried to revert it in December, but as it was seen as a big business issue, it got tangled up in other issues. There's a new bill in the Senate to revert it, and it’s gaining co-sponsors, but still moving slowly.

No one in Washington thinks this is good tax policy... but they don't feel any urgency to act on it.

Here's where we, the little guys, come in.

Every politician loves small businesses. Big Tech may not be popular on the Hill, but they love small businesses. The problem is, they're barely aware we small software businesses exist, never mind that this unintended policy is having drastic consequences for small software businesses (and other small businesses).

So! I am leading an effort to get small software businesses' stories in front of Congress. We're sending them a Coalition Letter, which is like a formal petition that goes directly to Senators' and Representatives' offices, and is something our advocates can use in the negotiations to get them to understand that this is an urgent issue.

Here is what you can do about this

1. Ask you accountant about how the Section 174 changes impact you

2. Sign the Coalition Letter. EVEN if your business is a side project. EVEN if you don't have employees. EVEN if you are able to pay the higher tax bill. EVEN if the impact on you at the moment is uncertainty.

We already have 150+ signatures in 38 states from indie companies you probably recognize -- SavvyCal, Outseta, SignWell, HelpSpot, and many more.

Our goal is 1,000 signatures from all 50 states plus DC by April 10 so we can deliver this to Congress before Tax Day.

If you're a US citizen or resident and have a US business, sign the letter now: ssballiance.org

Note: if you're an overseas founder with a US company, unfortunately, you can't sign the letter. I do know that you are impacted even worse since the amortization is 15 years instead of 5, and don't have the ability to petition Congress. The best thing you can do is raise awareness by sharing ssballiance.org in your founder communities and on social media.