Tax Insights

Your Guide to State, Local, Federal, Estate + International Taxation

Deducting the cost of software development

software, software development, tax reform, deductionThis year you’ll start to see the impact of the largest tax reform passed in 30 years thanks to the Tax Cuts and Jobs Act of 2017. You’ve probably seen our blogs on tax reform from the last few months, including my earlier blog on computer software, which touched on “developed software.” The good news is the “old” rules for software development will stay in effect, for now. But after December 31, 2021, the rules for developed software are changing, and for planning purposes, it’s good to know what’s coming.

One of the most talked about changes passed with the new tax law is the depreciation rules. That is, starting from September 28, 2018 through December 31, 2021, you may be able to take 100% bonus depreciation on all eligible capitalized assets. That’s huge! But as with most things in life, there is a catch and I found something interesting that I thought I would share with you. This 100% bonus depreciation rule will no longer apply to software development after December 31, 2021. They will then fall into the research and experimental (R&E) expenses, as determined under Section 174. This means that any software developed, including any amount paid or incurred in connection with the development, must follow the old rules found in the link above until December 31, 2021.

Starting on January 1, 2022, the development costs in the U.S. must be amortized (taken in equal parts) over five years and any software developed outside the U.S. must be amortized over 15 years. In layman’s terms, this means that you cannot immediately deduct your development costs as the new depreciation rules may have had you thinking you could. You must break the expenses up and take them over a five or 15-year time frame.

Before you totally freak out, remember that if you are a C Corporation, tax rates dropped from 34% to 21%, and if your pass-through entity qualifies for the qualified business income deduction, you will receive a potential 20% deduction of that business income. This should help with the new software development rules.

Please contact your Henry+Horne professional tax advisor for advice on how this could affect your business.

Meghan Scott, EA