Escaping the Tax Trap – Update September 2024

In a previous post, we wrote about a little-known but potentially momentous tax change for software companies.  Essentially, starting in 2022, any amounts spent by a U.S. company on software development were no longer permitted to be deducted against income, but instead had to be capitalized over several years.  This “tax trap” meant that many engineering-heavy SaaS companies operating near cash flow breakeven could suddenly appear profitable “on paper” (and on tax returns), leading to an income tax liability.

A broad consensus formed by mid-2023 – among tech companies, pro-growth politicians, and tax professionals – that this was probably not what Congress really wanted and that it was a Bad Thing for innovative, entrepreneurial companies.  But, this language, known as “Section 174,” was the black letter of the law, and would take a literal act of Congress to fix it.

There have been a few runs at a Section 174 fix, and the farthest one along at this point, H.R. 7024, passed the House of Representatives on January 31, 2024 in a landslide 357-to-70 bipartisan vote (hat tip to sponsor and tax committee chair Jason Smith, R-MO and his co-chair, Ron Wyden D-OR).  However, the bill got hung up in the Senate and got put on hold before the summer recess.

H.R. 7024, the prospective “fix” titled “Tax Relief for American Families and Workers Act of 2024,” provides for a new “Section 174A” which essentially fully repeals the prior Section 174 changes, allowing for a full deduction and specifying that software development is covered.  And it appears that this change is fully retroactive back to the January 1, 2022 start date for the Section 174 changes, meaning that it should provide full relief – but only through 2026, when a new “fix” will become necessary.

However, none of that will matter unless the Senate takes up the bill during this Congress.  The Senate was on summer break until last week, and reconvened Monday, September 9th.  We think H.R. 7024 is a good idea and important, and if you do as well, consider letting your Senator’s office know here.

Randall Lucas

Managing Director, SaaS Capital

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