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startups can no longer deduct (aka subtract) r&d expenses from revenue.
for software or product development costs, you now have to capitalize (aka spread them out)
over 5 years if they’re domestic, and over 15 years if they’re foreign (aka offshore).
because of something called the ‘mid-year convention’, year 1 counts as only half of a year.
so functionally, you can only deduct 10% (not 20%) of domestic r&d expenses
— and only 3.33% (not 6.66%) of foreign expenses — in the first year, 2022.
this creates a substantially larger “computed” taxable income → an actual tax liability.
you may be thinking “whatever i’ve got NOLs” — but even those have been neutered:
you can now only use NOLs to offset up to 80% of your “computed” taxable income.
“hey you have a big tax liability now — and oh you can’t really use your NOLs to wipe it out.”
all the while, this added tax burden means it’ll become harder to stockpile NOLs like before.
it’s a combo fucking judo move if i’ve ever seen one.
all of a sudden, you can no longer separate NOLs and R&D in your thinking.
your startup’s revenues and expenses, NOLs, and the new tax code need to be baked together.
even future headcount planning and revenue projections roll into your complete tax strategy.
the semi-good news is that your startup likely already has a very healthy reserve of NOLs,
so you'd only really have to worry about covering the remaining 20% with r&d credits.
aka optimize the allocation of r&d expenses such that whatever is capitalized
— ironically the same (ish) type of expense used to generate an r&d credit —
creates a taxable income just big enough to have 80% of it wiped out by NOLs.
the remainder will get taken care of by the income tax r&d credits.
plus, if you model out + expect future years to have computed taxable income,
you can be sure to build up a healthy enough reserve of deferred tax assets.
you'd only need 1/5 the tax credits since they'd offset the tax burden itself,
as opposed to the NOLs which only offset computed taxable income.
apart from often being inaccurate, this method presents a new problem under the new rules:
the well-known strategy of ‘throwing in the kitchen sink’ to maximize your r&d credit
will create a larger tax bill in its wake than the credit it alleges to claim for startups.
instead, startups need to start planning and optimizing their tax strategy,
while optimizing — not maximizing — their r&d tax credit along the way.