***Update, please make certain a tax professional is consulted as tax rules and laws change***
Software capitalization is an important consideration when estimating or calculating a software project's financial performance and impact on an organization. Not understanding the rules can have a big impact on a company. For example, in 2022, Internal Revenue Code (IRC) section 174 went into effect and eliminated a business's ability to, in many cases, deduct their R&E expenditures as expenses. Businesses must now capitalize on these expenses and amortize them over a period of five (5) years and fifteen (15) years for foreign corporations. This can mean significant tax liability!
Capitalization can have significant near and long-term implications, and getting it right is no easy task. Companies often don't have processes and systems in place to track and categorize expenditures appropriately, and many don't understand the rules and requirements to capitalize. Agile-based product development has made this even more challenging.
In the article, Accounting for external-use software development costs in an agile environment by Ryan Bouray and Glenn Richards of Crowe Horwath LLPT in the "Journal of Accountancy" highlights the nuances of capitalization of external use software in an Agile environment [1].
For additional information and a good primer explaining capitalization of software costs, the Withum Smith+Brown, PC website, has a great resource, by Chris Demayo, How Tech Companies Deal With Software Development Costs: Insights From A CPA [2].
Software capitalization decisions are usually driven by the financial leadership of a company. Tax treatment and accounting rules can change. It is important that project and technology leadership stay current, understand company direction, and be familiar with this important accounting and finance concept, as it can influence management, resource, and budgeting strategies.
References and Citations
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