You Thought You Were "Bootstrapping." The IRS Thinks You Are Rich.
I had a call with a Founder yesterday. He was crying. He runs a SaaS company.
- Revenue: $2 Million.
- Expenses (Developer Salaries): $2 Million.
- Profit (Cash): $0.
He thought he would pay $0 in taxes. His CPA just sent him a tax bill for $150,000. He doesn't have the money. He has to take a loan to pay taxes on money he didn't make.
This is the Section 174 Nightmare. In the "Good Old Days" (pre-2022), you could deduct your engineers' salaries instantly. In 2025, the IRS says: "Writing code is R&D. R&D is an investment, not an expense. You must spread that deduction over 5 years."
Here is the math that is killing software companies, and the legal moves you need to make right now.
1. The "Amortization" Trap
Let’s look at the math that destroys startups. You pay your developers $1 Million this year.
- Old Rule: You deduct $1M. Taxable Income = Revenue - $1M.
- New Rule (Section 174): You can only deduct 10% ($100k) in Year 1.
The Result: Even though you spent that $1M on salaries, the IRS says you still have $900,000 of "Taxable Income" sitting there. At a 21% corporate rate, you owe $189,000 in taxes. But you don't have the cash. You paid it to the developers. You are now borrowing money to pay taxes on a "profit" that only exists on paper.
2. The "Overseas" Death Blow
It gets worse. If you hire developers outside the US (Contractors in India/Ukraine/LatAm), the amortization period isn't 5 years. It is 15 years.
If you pay a remote team $500k:
- You can only deduct $16k this year.
- You are effectively taxed on 97% of your gross revenue, regardless of your actual burn rate. This kills the "Offshore Model." I am seeing founders fire their entire offshore teams just to stop the tax bleeding. If your team is international, you are walking into a minefield.
3. The "R&D Credit" Lifeline (The Only Way Out)
How do you survive this? You have to fight fire with fire. You need to file for the R&D Tax Credit (Form 6765). This is a specific credit that offsets the payroll tax you owe.
- The Good News: It can save you up to $250k/year if you are a startup (<$5M gross receipts).
- The Bad News: You cannot do this yourself. If you try to fake it, the IRS will audit you. You need a specialized "R&D Study" from a tax firm (Cost: ~$10k).
The Strategy: Spend the $10k on the study. It is the only thing that might lower your effective tax rate enough to keep you solvent.
The Real Numbers: Cash vs. Tax
I modeled the tax liability for a standard bootstrapped SaaS in 2025.
| Metric | "Old Rules" (Expensing) | "New Rules" (Section 174) |
|---|---|---|
| Revenue | $1,000,000 | $1,000,000 |
| Dev Salaries | -$1,000,000 | -$1,000,000 |
| Cash in Bank | $0 | $0 |
| IRS Deductible | $1,000,000 | $100,000 (Year 1) |
| Taxable Income | $0 | $900,000 |
| Tax Bill (21%) | $0 | $189,000 |
The Verdict: If you are running at "Breakeven," you are actually running at a loss because of the tax bill. You must raise your prices or fire staff immediately.
Frequently Asked Questions (That CPAs Charge $500/hr For)
Does this apply to contractors?
Yes. If the contractor is writing code (developing software), they fall under Section 174. It doesn't matter if they are W2 or 1099. The IRS looks at the activity, not the employment status.
Can I just call them "Marketing Support"?
You can try. That is called "Tax Fraud." If the IRS audits you and sees a GitHub commit history for a "Marketing Assistant," you will go to prison (or at least face massive penalties). However, legitimate "Maintenance" (bug fixing) might be deductible immediately. You need a lawyer to define the line between "New Features" (174) and "Maintenance" (162).
Will Congress fix this?
They keep promising to. They haven't yet. Do not run your business hoping for a retroactive law change. Assume Section 174 is here to stay. Plan your cash flow for the tax hit now, not in April.
Leon Staffing connects founders with "Maintenance-Focused" engineers who might help you navigate these classifications legally. Talk to us about tax-efficient hiring structures.