Software Development Expenses

Section 174 changes have shaken up the Silicon Valley. The recent IRS guidelines make it clear that most software development costs must be treated as research and development and therefore capitalized over a course of 5 years if the software is developed in the USA and 15 years if developed overseas. In simple terms, before, if a company spent $100,000 during a tax year on software development costs, they could deduct 100% of it on their tax return. From now on, $100,000 must be depreciated (capitalized) in $20,000 annual amounts. IRS also makes it clear what is considered software development. The following costs must be treated as such:

• Labor - salary of employees and contractors directly involved in development.

• Indirect costs related to equipment necessary for development and even lab or office

• Patent and some other legal costs

• Supplies and materials

Costs that can be excluded from research and development are:

• Accounting of R&D activities

• Website hosing

• QA costs

• Marketing research about the need for the research

Multiple attempts have been made to overturn this provision but as of writing of this article, it remains effective.