Capitalize Costs of Software Development

Abstract

Under current law, a taxpayer may deduct the costs of development of computer software. Software development is also eligible for a 20% tax credit, an exclusion of 9% of revenue and expensing to purchasers of software. With all combined, an investment can lose over 7% of its costs per year, with the tax subsidy making the investment justifiable. The proposal would capitalize the cost of development of computer software under section 263A of the Code. It would allow recovery of the costs over 15 years, but adjust basis yearly to adapt to value determined by current revenue extend over the remaining tax life. It would replace the 20% credit given for routine software development with a National Science Foundation prize for extraordinary development. It also recommends administrative action by giving notice that software is a separate and distinct asset, and by making routine application of the computer programming skills ineligible for the credit.

The proposal is made as a part of the Shelf Project, which is a collaboration among tax professionals to develop and perfect proposals to help Congress when it is ready to raise revenue. Shelf Project proposals are intended to raise revenue without raising rates because the best systems have the lowest feasible tax rates and taxes that are unavoidable. Shelf projects defend the tax base and improve the rationality and efficiency of the tax system. Given the current calls for tax stimulus, some shelf projects may stay on the shelf for a while. A longer description of the Shelf Project is found at “The Shelf Project: Revenue-Raising Proposals that Defend the Tax Base,” Tax Notes, vol. 117, p. 1077 (Dec. 10, 2007). Shelf Project proposals follow the format of a congressional tax committee report in explaining current law, what is wrong with it, and how to fix it.

Keywords: software, capitalization

JEL Classification: H20, H25