New R&D tax rules could bankrupt your blockchain startup

The new R&D law has overly broad language stating that “any and all” software development must be amortized over five years if the development took place in the United States, or over 15 years if the work was done abroad. The change doesn’t sound so bad on the surface; some argue that it could even create more tech jobs in the United States

But that’s not how it will play out. Many countries have better R&D credits than the US Much US software development will move to countries like the UK, where the rules are simpler and more lucrative. For tax-savvy companies, US entities will only be for marketing and sales.

Imagine a company that lost over a million dollars but owes over $300,000 in taxes! How is this possible? This hypothetical company has about $2.5 million in revenue and in 2022 spent $1.5 million building the software and $1 million in other costs, meaning it had a total negative cash flow of $1 million. However, because the $1.5 million development was done by a team in India, it will only see $50,000 from the software development side, leaving a deduction of $1,050,000 to offset the $2.5 million in revenue this year – meaning it owes taxes on $1,450,000 of net income. , or a bankruptcy on $304,500 in taxes!

Supporters of this tax say that the companies will still receive all the benefits of the deduction – for many years to come. Put one of these advocates in front of a company that lost a million on operations but owes $300,000 in taxes and see if they say the same thing. Cashflow is king in finding startup success, and this type of R&D expense has been deducted for almost as long as the US has had an income tax because of how important innovation is to fueling national growth. In today’s climate of high interest rates and increased regulation, this law change will kill the most creative developments in the US on forward-looking technology, such as AI and blockchain.

Some of the Big Tech layoffs that are taking place may be a result of this rule change. No surprise: It makes more sense to restructure so that subsidiaries outside the US do R&D. For blockchain, crypto and NFT companies that already have to deal with all the Securities and Exchange Commission’s scrutiny, it seems like it’s easy to distance yourself from the US now.

Related: Get ready for a swarm of incompetent IRS agents in 2023

There are so many complications and unanswered questions about how to apply this law that it is mind boggling. For example, if you use a computer, server, miner, etc., for your R&D that you depreciate, the portion of the depreciation you will be able to take in 2022 must be added to the capitalization bucket to be amortized. This means that if you used this tool in the US and expected to get $50,000 in depreciation from that equipment to deduct this year, you would only see $5,000 of it actually impacting your bottom line. This essentially defeats the purpose of special depreciation rules that encourage businesses to spend on equipment but don’t actually allow them to see the deduction.

Another big risk with this law is if you raise money and develop with a big loss and no ongoing income. Initially, this wouldn’t hurt you – but if your company fails, you’re in for a world of pain, because writing off debt proceeds from a SAFE note that wasn’t repaid could trigger taxes if no net operating loss carryforwards have been fully offset. And there is currently no way to speed up the R&D amortization; even if a project is abandoned or a business closed down, the expenses cannot be taken immediately. This means that equity investors may not get back funds they should receive. Instead, the money in the treasury will go to pay taxes for a failed company while entrepreneurs who received a salary may even be on the hook for tax liability or paying back investors.

Related: Biden is hiring 87,000 new IRS agents — and they’re coming for you

Everyone in government and the tax industry knew these laws were a mess, and they were going to be repealed by a bipartisan bill in Congress on January 3rd. But the effort failed because Democrats wanted to increase the child tax credit — at last minute — after everything was agreed, and Republicans wouldn’t go along with it.

Now it looks like we’re stuck with this crazy innovation-killing tax law. A repeal proposal has been reintroduced, but has not gained much traction. Especially in light of the current fundraising challenges for blockchain companies caused by rising interest rates, the crypto winter, and the Silicon Valley Bank failure, we could see a massive and unnecessary death of tech companies unless some major action is taken by Congress quickly.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.