Act now before it's too late: Section 174
Hello. Welcome to Build Your SaaS. This is the behind the scenes story of building a web app in 2023. I'm Justin Jackson, the cofounder of Transistor dot f m. And today, on the call, I have Michelle Hanson, co founder of Geocodio, and we're gonna be talking about something very exciting, which is section 174.
Justin:Hi, Michelle. How are you doing?
Michelle:Hi. How are you?
Justin:1st of all, Michelle, last I heard from you, You were going into hibernate mode. And the way I understood hibernate mode was you were going to offload some of your side Jax. You know, stop recording the podcast for a while. No writing of new books. Nothing extra.
Justin:Not Doing any public speaking, I'm just gonna relax. I'm gonna focus on me. I'm gonna focus on my family. I'm gonna focus on Geocodio. What happened?
Michelle:Yeah. Oh, I wanna go back in my cave, man. Yeah. Section 174 is what happened, and I can't wait to go back into hibernate mode.
Justin:Okay. Yes. Where It this was kind of I mean, it's not out of left field because it's this legislation's been proposed for a while. Maybe for folks who don't understand what section 174 is, could you give a brief description? And maybe then we'll talk about why it matters for small software companies.
Justin:So what is section 174?
Michelle:The very high level is that section 174, and specifically what we're talking about is reverting section 174, is a part of the US tax code. So we are talking about, anyone who has a US business, that builds or sells software. And this is the part of the tax code that deals with what is called research and experimental, which is different than r and d.
Justin:Okay.
Michelle:And, Basically, for for, I wanna say, about 70 years, since this section came into being, software development was considered among this, research and experimental or R and E spending.
Justin:Okay.
Michelle:And then what happened was And and under this section, you had the choice to either, take all of those expenses immediately, which is to say let's say you spent $10,000 last year, building a new product. You had server costs. You had icon libraries. You had a UI library. You had all this stuff that you use to build it.
Michelle:Right? That $10,000, you could choose either to take that as an expense right away, so that's negative $10,000 from your taxes, Or you could choose to amortize it, which is basically have it spread out over many years, Which is something you hear very commonly about computers. Right? Like Mhmm.
Justin:All of
Michelle:us kind of know, like, if you buy a new laptop, you don't get to take off a 100% of that In the year that you bought it, that has to be spread out over many years because you get, you know, 5 years, of life out of that. Right?
Justin:Mhmm.
Michelle:And so For, basically, forever, companies could choose to either expense these expenses, software software development among them, or, spread them out over many years. Yeah. Now in 2017, there was a, Big piece of tax law, in US. Mostly, it was tax cuts. And A part of the sort of maneuvering to pay for those tax cuts was to say that and this is also a benefit of it.
Michelle:They said for 5 years, companies can expense all of this r and e spending.
Justin:Yeah.
Michelle:But then as of January 1, 2022, which is 14 months ago
Justin:Yeah.
Michelle:It must be amortized. So companies no longer had the option or have the option to take it as an expense.
Justin:Like, what what's the proposed benefit to the government for doing it this way?
Michelle:The thing about this is that when Congress passed this law In 2017, it was known, that it was basically part of the package that was that was paying for these tax cuts and sort of just kind of In the same way that many governments push the problem of paying for, retirement off to the next generation Yeah. This was kind of doing that to companies except only 5 years down the line and not, you know, 30, 40 years down the line.
Justin:Got it.
Michelle:And so they knew when they were passing this bill that the intent was that they would revert this change before it took effect. So it was basically kind of some accounting sleight of hand, as they were passing this bill. At this point, we can get upset about that, or I think where I'm choosing to spend my attention is on The likely catastrophic impact it will have on companies that build software and then doing something about it.
Justin:Yeah. Yeah. So this was this from my perspective, it looks like this was political maneuvering. Nobody expected this to go through, really, but now it looks like it it has gone through. And now I'm seeing tweets from founder friends who are like, we're doing our taxes, and instead of paying $75,000 in taxes this year, we're paying $225,000 in taxes this year.
Justin:Or instead of my taxes being, 30%, they've gone up 350%. So it's having a meaningful, impact on people right now. Are you seeing that too?
Michelle:Yeah. And and this is also something that companies have been predicting for a long time. And so, bigger companies think, you know, Netflix and Zoom and, Microsoft, Intel, like, since 2019, they have been talking to congress about this saying, hey. Remember that tax provision that you didn't intend to take effect? We haven't forgotten about it.
Michelle:Let's just make sure that we Fix this before 2022 when it takes effect. And they've been sending letters and and and talking to congress about this for 4 years now, and everybody thought in 2022 that it was going to be reverted before it took effect in December, and then it kind of fell apart at the last moment with some negotiations. And and then so we get into this year, and I think we, small business owners, like, hadn't really been included on it because I mean, like, I don't Track, like, policy legislation is part of my like, I'm too busy, like, responding to customers and, like like, building software. Right? So and dealing with sales taxes.
Michelle:So, so Yep. Now we get into this year, And, our accountants are starting to say, so there's this change that congress didn't intend for it to take effect, but it did take effect. And now all of your software development and new features you're adding, new products you're building, stuff you probably don't think of as r and d, salaries, servers, Icon libraries, whatever it is, all of that is now has to be amortized. That's no longer an expense. You can only take 10% of it for 2022.
Justin:I did not realize that, that it's not just Salaries. It's also any other expense related to software development.
Michelle:Right. So this means, for example, that if you are and and and so the the crazy thing about this is also that a congress didn't intend for it to take effect. But since they were widely, like, expected to fix this before it took effect because Nobody in Washington thinks it's good tax policy.
Justin:Yeah.
Michelle:The IRS did not write release the full guidance on how tax preparers implement this. Mhmm. They issued sort of something that's being taken basically as a warning in January that was like, hey. Remember, This happened, but it doesn't actually define software development.
Justin:Yeah.
Michelle:But I have been talking to a lot of experts about this in the past couple of weeks, And it is increasingly clear to me that section 174 is bad news For every company that builds software, not just ones that have employees, not just ones that are c corps. Like, If you have an LLC and you're only building a product right now and you're not even making any money, you're gonna owe taxes because of this. Like, it's very you're likely to owe taxes rather. Wow. It's everything.
Michelle:I mean, I was thinking about this the other day. It's like, if we So so so so, again, the IRS has never had to define software development, so we're gonna have to we're waiting for that from them. But Yeah. If they take the definition of it that most of the major accounting firms Expect them to take and what, you know, big companies have been warning about in their public filings. Like, you can find VMware, like, warning about the tens of 1,000,000 of dollars in additional taxes they're gonna have to pay in their filings last year.
Michelle:Yeah. Like like, are are developers are is are all developers gonna have to be time tracking? Like
Justin:Yeah.
Michelle:I mean, everybody's mean, people are usually so relieved to stop doing client work and stop time tracking. And now it's like, wait a minute. Well, was that new feature development, which is now this r and e expense that has to be amortized? So not only your if you get a salary, right, that has to be part of that. But also, Kaye, I guess, the staging server that you were using, that Part of that expense is now under this different category.
Michelle:For that. Okay. That's now, has to be capitalized. Right? Like, versus, well, you were fixing a bug later, And so that is actually just a regular business expense, so we get to write that one off.
Michelle:But then what if we're doing a UI improvement that is that a bug? Is that, like, is that a new feature if it's making it easier to use because people were not realizing there was this functionality. Like, it's a nightmare. It's an absolute nightmare, and I think the fact that big companies have been writing to congress about this for 4 years now. I mean, it it it shows how much of a problem this is.
Michelle:Before we get into this conversation, Justin, it's very important that I note that I am not a tax accountant. And for advice about your specific situation, people should consult an accountant.
Justin:Yes. The same applies for me. We are not accountants. We are not lawyers. We are not giving investment advice.
Michelle:Just play 1 on TV.
Justin:This is just for informational and entertainment purposes only.
Michelle:And call to action purposes, really. I mean, that's why that's why I'm here is not to, You know, be the the rain on everybody's parade, right, is to say, yes. This is a big problem. Congress kinda made it Mhmm. You know, 5, 6 years ago.
Michelle:Big companies have been trying to do something about it. Didn't work, and that's where we come in.
Justin:Yes. So, let's talk about what you've been organizing During your hibernate mode. So you have this amazing website, s s b. So s as in as in Sam, s as in Sam twice. Right?
Justin:SSB Alliance .org. So tell us what you've done so far and what's kind of in motion right now.
Michelle:So what's in motion right now is to get small software businesses into this conversation and hopefully get the message through to congress that this is an urgent problem that needs an urgent solution. Mhmm. So, you know, congress, in December, they tried to repeal this. I mean, there was broad bipartisan support. Like, there isn't anyone who thinks this is a good idea, but it was seen as kind of a big business issue, Which meant that it got parlayed off of a whole bunch of other different issues, and it all got very complicated and fell through.
Justin:Mhmm.
Michelle:And this year, There is still a chance this is going to, get reverted. There is, again, broad bipartisan support for this. Nobody thinks it's a good idea. Nobody thinks it's good tax tax policy, But it's still seen as a big business issue. And the problem is is, like you, I'm either opening emails from my accountant about this, or I'm opening Twitter and seeing All of my friends freaking out see saying that they might have to do layoffs, that they're taking out loans, that they're using their personal credit cards, or that they have no idea and their accountant hasn't told them, and they are getting really worried.
Michelle:Mhmm. The thing the thing about this is that small businesses, like, everybody loves small businesses.
Justin:Mhmm.
Michelle:Right? Especially policymakers. I like to say, you know, We are the cute puppies of the policy world. Just basically everybody loves small businesses.
Justin:That's right.
Michelle:But right now, because of section 174, We are getting run over by a truck, and congress has no idea.
Justin:Yeah.
Michelle:Because they are thinking, okay. You know what? We should we should fix this. We can do that later in the year. We can push this again to December, push it to the last minute, get something through.
Michelle:And, you know, big companies, they have access to credit markets. They can they can, you know, shoulder an extra 10, $20,000,000 in a tax bill in a year Mhmm. And knowing that they're gonna get it back later. Right? Because this the this would not only fix it, but also revert it so that it basically didn't take effect.
Michelle:Yeah.
Justin:And then
Michelle:you would get a refund for 2022. But if you're a small business and your tax bill has just gone from, You know, $75,000 to $225,000 Mhmm. And you're making, you know, 1,000,000 or 2 a year. That's Huge. Like, you may not have that money.
Michelle:You don't you can't just go sell stock in order to get that money back. You can't just go to the bank and get a loan because, I mean, The only bank that was friendly to to to to software companies, like, literally just went kaput. Like Yeah. Like and most of us didn't even use them. We use normal banks that, like, Barely know what software is in the 1st place.
Michelle:Like Yeah. So this is a huge problem for small businesses. We can't wait a year to get a refund check for this.
Justin:Yeah. Like,
Michelle:we can't wait. And so what you probably know about me is that I am an indie founder. I wrote a book. I have a podcast, all that fun stuff. Way back when, I used to live and work in DC.
Michelle:Okay. And so when I heard about this and I I have some friends who work in the policy world, I remember them, like, kinda saying at the end of last year, like, this big thing I've been working on, like, you know, it didn't go through, and I'm, like, super bummed about it. And, like, I mean, I'm, like, super checked out on politics. Like, I'm just kinda, like, working and, like, you know, I got a general idea of what's going on, but, like Yeah. Definitely not following policy.
Michelle:And I'm like, oh, That sounds, like, really rough. I'm sorry you've worked hard on this. Like, it didn't work. Like, go started talking about this, and I started hearing about it. And I was like, so is this this thing that you were all upset about in December?
Michelle:And they were like, yes.
Justin:Wow. I was
Michelle:like, oh, because all of my friends are upset about it now. Mhmm. And so I have basically been pulling out all the connections I've got to get us into the conversation in DC
Justin:Amazing.
Michelle:And to Get us, the cute puppy small businesses Mhmm. In front of Congress so that they understand, this is an issue. Right? And and and let me do an analogy here. This issue is kind of like you know, for this is for anybody who has teenagers, who's ever been a teenager, which I know it's you.
Michelle:Yeah. It's like a pile of sports equipment sitting in the hallway. Right? That might be hockey equipment. It could be soccer cleats.
Michelle:Whatever. It's sitting in the hallway, and it sits there for a couple of days. Everybody knows it's a problem. Everybody knows it shouldn't be there, but everybody just keeps walking by. Yeah.
Michelle:And then One day turns into another, and this pile of sports equipment starts smelling really, really Terribly.
Justin:Yep. It's a good analogy.
Michelle:And the person who should be cleaning it up is playing Mario Kart, and there's guests coming in 10 minutes. Right? And so we need to be, You know, the person who kinda runs in there with a wooden spoon and says, hey. This is a problem. Guests are coming in 10 minutes.
Michelle:There's a pile of, You know, dirty equipment in the hallway. Like, we need to get this done now. We cannot wait. And so What I'm doing, is, you know, first, sort of getting us together. Right?
Michelle:We are not the most organized bunch.
Justin:Mm-mm.
Michelle:Just trying to organize people and then getting people in front of policymakers. So, like, members of our community, because of this effort, have already talked to Hill staff, already told them about how they're taking out loans and how this is affecting them. Yeah. But the big thing we're doing now is we're gonna have a coalition letter to Congress, which is basically this is a formal letter to Congress that will go directly to their offices. This is not something that we just put in a contact form and pray.
Michelle:This is going directly to their offices because of these friends that I have
Justin:Amazing.
Michelle:And describes the impact that this is having on small software businesses. Now I know that many of us, we don't even know what the impact of it is yet.
Justin:Yeah.
Michelle:That's okay. Like, if your accountant hasn't found out about this yet or hasn't told you about it yet and you're worried about it, you can still sign this because you are almost certainly going to be impacted by this. And but there are people who are who are, like, laying people off. Or, I mean, we were talking about hiring yet another developer this year, and that conversation has just gone out the window. Mhmm.
Justin:We just hired somebody else.
Michelle:Oh, did you? Yeah. Congratulations. I mean, there are companies facing bankruptcy already because of this. Like, this is Very, very like and and I have this form up just kind of collecting everybody's emails and their addresses so we know which congressional districts they're in and kind of how it's impacting them so far.
Michelle:And, like, it is it is just breaking my heart every single one of these emails that I get. That that's like, You know, we got through COVID. We thought things were gonna be good. Mhmm. Like, we finally felt like we're back on our feet again, and then this happened.
Michelle:Right? And we don't have The money for it, banks won't work with us, like personal credit cards, I guess. Right? And so we need to get this letter in front of Congress. And these things are very, very effective.
Michelle:So there was a group of small Biotech companies that sent 1 a few weeks ago, there were 500 small biotechs that signed this letter, which Awesome.
Justin:I think
Michelle:that means we can do a1000. Right?
Justin:Yeah.
Michelle:A senator, Like, mentioned this letter in a hearing a couple weeks ago. Like, these things really make a difference because when That, like, there are policymakers who are they're already cosponsors of the bill to fix this. Right?
Justin:Yeah.
Michelle:When they're going to their colleagues, when their staff is going to their colleagues, This is a letter they can bring with them and say, here is very tangible impact of very small businesses seeing tax bills that are 400% higher, than previously for a policy that we never intended to implement. Yeah. And so As many people who are US citizens, sorry, can sign this. Right? Yep.
Michelle:Like, all 50 states Plus territories, we we have to do this. Right? Because this is up to us at this point. Yeah. The big companies have tried.
Michelle:It's stuck as a big business issue. It's not a big business issue. This is also a small business issue. And so we have the opportunity to get in there, shake things up a bit, and say this is this is not a hypothetical issue. This is this is not Something that's only gonna affect, you know, the Facebooks of the world.
Michelle:Right? Like, this is a this is gonna impact small businesses in Kansas and Missouri and Pennsylvania and Arizona as much as it is the companies in California who are, you know, already hurting.
Justin:Yeah. And and just to, Again, to give an a practical example of this, like, a transistor, I think, like a lot of bootstrapped software companies, we we spend most of the money in a year. We take it out as owner with owner, distributions. We Take it out as, pay our staff really well. So we don't have a lot of cash in the bank.
Justin:We run it just a nicely in operation, and we know that Every month, we're gonna have more cash coming in from recurring revenue. But if you've been running your business like that, That means that and and and you just have this expectation that any expense you have is an expense for that year. And so you can take most of the money out of the company. So if you run lean, like a lot of us do, That's where it's gonna get you because now you're gonna need instead of needing to have whatever you normally have in your bank account, a 100,000, 200,000, 500,000, whatever, You're gonna need to have way more just to cover the tax bill, especially year 1. And, There's this great Wall Street Journal piece that you link to on your site.
Justin:I'll quote from that. Laura Lynn Gonzalez expected a tax refund this year after her two Employee data visualization company experienced a $30,000 loss. Instead, she said she's facing a $100,000 federal tax bill that is about as large as her 2 2022 salary. That's what this looks like. It looks like if you don't have the cash To pay the tax bill, that's where you're gonna get in trouble.
Justin:And, it works great when you can expense, You know, when you can expense developer salaries and developer costs as a full expense in that year, running lean works that way. But if you If if that's the way you've been running it and if, you know, LLCs, you're probably taking nice distributions. You know, all of that's the way you've been working won't work under this legislation. That's why it's so important, because you're you're gonna need to come up with maybe 100 of 1,000 of dollars in cash to pay a tax bill.
Michelle:It's nobody really expected this to happen. And then now that it is and we are all getting these tax bills or sort of very slowly. Right? Because there's people I've talked to who didn't their accountant didn't realize that this was happening. Mhmm.
Michelle:So now they're not only facing the huge tax bill, but also Penalties Mhmm. And that 5 year depreciation we talked about for for spreading it out. If you are running a remote company, which a lot of people are, you've got maybe you've got contractors all over the world. Foreign R and E expenses are 15 years.
Justin:Oh my gosh.
Michelle:Yeah. Like, so if you've got, You know, a lot of people have a team in in, you know, in in Southeast Asia or in Eastern Europe or just, I mean, spread out all over the world. Right?
Justin:Yeah.
Michelle:That's 15 years Wow. For that development expense. And so this is I mean, it I hesitate to say it because it feels dramatic, but section 174 is an existential threat to anyone who builds software.
Justin:Yep.
Michelle:Even if you're only making $10,000 a year.
Justin:Mhmm.
Michelle:Yep. Even if you don't have any employees. Yeah. This is a problem. And in, I mean, this is I don't know.
Michelle:It it feels a little bit like putting the rookie in at the end of the game to throw the Hail Mary, you know, to to to win the game. Right? But it's, like, up to us, the little guys, to do this. But folks like, folks in DC, they are very receptive. Like, I've had some great calls with people.
Michelle:They are Happy to have us on board. We're getting help. Like, we're like, this letter is gonna go straight to Congress. Like, People you probably know on Twitter have already talked to Hill Staff about this because of this effort. Yeah.
Michelle:It's I I I didn't come out of my hibernation for nothing. Like, this is a really, really serious problem. And we cannot rely on the bigger companies to sort this out. Or as you said a couple weeks ago, We can't have magical thinking and just pray that it doesn't impact us. Yeah.
Michelle:This is going to impact us. Yeah. And we have a responsibility to do something about it and Yeah. Can do something about it.
Justin:Yep. Yep. So we folks, if you're listening right now and you are a US citizen and you have you're doing anything on the side, you have your own software company, Go to SSB Alliance .org right now while you're listening. Sign it, And then send it to your friends. Explain to them what's going on.
Justin:And you're right. We need to have a 1000 people sign this. There's There are many, many small software businesses in, the United States. And, the more People that sign this right away, the bigger, the louder we can make our voices. And we can We can actually have a chance here, especially with Michelle's work, to make a difference.
Justin:We can actually get this into the hands of the right people. And, again, like she said, small business is such a strong political motivator. Like this, we actually do have some power here, And we need to use it, especially because the culture has become kind of antagonistic towards big tech, while Small business, like mom and pop shops, we have, a good reputation in the culture, and we can use that to say, hey. You gotta help us out here. Or, like, honestly, I don't know what we would do even.
Justin:So that's this is your call to action. Go to SSB Alliance .org. Michelle's been really good at communicating with everybody, Sending updates, telling folks exactly what they need to do. It'll take you 10 seconds to sign up and then another 30 seconds to a couple minutes to do, what Michelle's asked folks to do. Do you wanna just quickly run through what people can do besides sign up for SSB Alliance .org?
Michelle:So if you go to SSB alliance.org now, you will be directed to sign the coalition letter. And then there was also the option to stay updated, which is basically mandatory because if it turns out that you're in a really pivotal Congressional district, we want you to talk to your representative. And so it's really important to have your whole address in there. I'm not sharing that with anybody. Your email isn't getting shared with anybody.
Michelle:Like I said, I used to work in DC. I know what the tricks are when you fill out forums about politics where like, I'm still getting added to stuff because of the Obama 2008 list. I am not doing that to your email.
Justin:Yeah.
Michelle:The only person who's gonna have this data. It'll get shared, you know, anonymously, like, in terms of this business in Michigan is saying that they're gonna have to lay people off. Right? Like, things like that, or I might reach out to you and say, hey. Would you be up for talking to a Hill staffer and sharing more about what's going on in your business?
Michelle:But nobody else is gonna see your information. The letter will have your name, your company name, and your location again because we need to show that these businesses are all over the country. I mean, it's kind of a funny thing where, like, Congress basically doesn't know we exist. Right? Like, small software com I mean, right.
Michelle:Like, we're kinda looked down upon in some corners. Right? Like, we're, oh, you know, lifestyle businesses. Right? Mhmm.
Michelle:This is our moment to have an impact. And so that is the information gathered. I'm the only one who's seeing that. Sign the coalition letter and do it on or before April 10th. We need to deliver this to congress before tax day.
Michelle:So April 10th is the deadline. S s b alliance.org to sign the letter. If you're listening to this after that, You can still go there and, just sign up for the regular mailing list, and so I'll keep you in the loop, on how you can help. Fine line.
Justin:Yeah. And thanks again, Michelle, for, like, for for deciding to Put yourself out there to use your connections and to organize this. I was really heartened because I feel like often Small business banners just don't wanna think about this stuff, and I get it, but this is real life. Like, this is actually happening. We we don't have a reality distortion field we can use here.
Justin:This is actually just real really what's happening. So thank you so much. I think everybody Michelle didn't ask me to say this. Everyone go buy her book. Thank her on Twitter.
Justin:Sign up for Geocodio. But most of all, just thanks so much, and let's help her do let's help her get this in motion. So Send this to your friends. Sign it right now. Spread the word, and, yeah, let's try to get this, Let's try to get this reversed.
Michelle:Thank you, Justin. And, I mean, if anybody else if you've got a podcast, if you've got any kind of present presence anywhere, LinkedIn, Twitter, wherever that is, if you have a presence among software founders, you need to use that Now Mhmm. If you wanna continue being a software founder and you want those people to continue being software founders, as well, We have to do something about this. And so just reach out to me. I did a a scary thing, which is open my DMs.
Michelle:So, Yeah. And I'm already getting so many Bitcoin raffle offers. Oh, no. Make it worth it, people. Okay?
Michelle:Reach out to me.
Justin:Yeah.
Michelle:I'm out of my hibernation. We're gonna make this happen. What we all need to be onboard to make it happen.
Justin:Yeah. Thanks so much, Michelle. You can get Michelle on Twitter, mjw Hansen. That's h a n s e n. She's got a lot of other links on her Twitter page, but then SSB Alliance .org will also, give you her email address, which is then you can be in contact with her directly.
Justin:And, yeah, let's get let's make this happen. And we'll let's do a follow-up episode after that deadline, which was April 10th. Yeah. After April 10th. Let's do another episode just update folks on this, and, we'll go from there.
Michelle:Sounds great. Thank you.
Justin:Thanks again.
