A US Business Tax Law Change That Partially Caused Layoffs (Section 174)
US corporate tax law is not an area of my expertise. But after reading an article, “The Pulse: Will US companies hire fewer engineers due to Section 174?,” I started diving into the changes to section 174. These changes were voted into law in 2017, signed by then-President Trump, and designed to be enacted in 2022. That’s an interesting date since in 2022, a different President would have (potentially) been in place, and it could look like this mess is theirs.
These changes going into effect in 2022 also coincide with the waves of layoffs that we’ve seen.
From what I understand, part of the revised tax law changes how certain types of workers and expenses are written off on a business’s taxes. The 2017 change to section 174 redefines workers and expenses related to research, development, experimentation, innovation, and software (let’s call this R&D for short). If you’re reading this, your job is probably in there.
Watch the video version of this article, which includes voice narration from the author, and a Q&A/discussion with those who were at the live webinar.
What do “R&D expenses” include?
- Labor costs. Salaries, freelancers, consultants, agencies, and contractors.
- Materials and supplies costs. This even includes office supplies.
- Patent costs. Anybody trying to innovate would want to file patents. This includes what you pay lawyers for patent-related work.
- Certain operation and management costs. This relates to facility and equipment costs such as rent, utilities, insurance, repairs and maintenance, security, cleaning, etc.
- Travel costs. Attending a conference? Displaying your tech at a convention? Need to go somewhere, anywhere?
As you might notice, this appears to be nearly everything related to work being done around research, development, experimentation, innovation, and software.
The redefinition has two main components that concern me and relate to the mass of lost jobs:
- Salaries and expenses related to R&D must be amortized over 5 years. A worker who made $X in 2023 is normally a tax write-off on 2023’s taxes. Under the new rules, this worker is written off in small pieces over years.
- Foreign (non-USA) expenses (human and non-human) related to R&D must be amortized over 15 years. The claim was that by giving businesses a smaller write-off for these workers, jobs would come back to America. We’ll examine later in the article if this amortization is enough of an incentive to keep jobs in America or move jobs back to America.
How will these be amortized?
I’ve seen different information from different sources. Some say that the 5-year amortization for non-foreign expenses is 10% in year 1; 20% in years 2, 3, 4, and 5; and the remaining 10% in year 6.
Some say that it’s 10% per year for the first five years, then 50% for year 6. Let’s use the first one in an example since either way, year 1 is probably a 10% write-off.
- Example: A company pays an Engineering team $1,000,000 in 2023. Under old tax law, they would have written off this $1M on their 2023 taxes. Under the new tax law, they would write off $100,000 in year 1.
So what? Why would this make companies lay people off?
Let’s pretend that you are an innovative, highly-experimental startup, scaleup, or small business. You made $2M in revenue in 2023, you paid $1M in salaries, and you had another $1M in rent, equipment, travel, and many things on the above list. Under old tax law, these are all write-offs for 2023, and you might end up paying no taxes if you end up with no profit or a loss.
Imagine this under the new tax law. You made $2M in revenue, but you can only write off $100,000 (10%) of your $1M in salaries. Maybe you can only write off 10% of your other $1M of expenses.
All of a sudden, you are a company with no real profit and nothing in the bank, but you have $1.8M of taxable revenue. You might owe hundreds of thousands of dollars in taxes. And you might not have the money to cover that.
This might not matter to the Microsofts and Googles, but to many small and medium businesses, especially those that are newer or were struggling through the pandemic, this change is devastating.
You would need to cut your expenses, and fast.
Two of the things probably costing your company the most are people and, if you’re not embracing remote work, office space and all of the expenses associated with it.
Companies often look to human layoffs as a first and fast way to cut expenses. Using the previous example, if you can cut your salaries by 20%, you’ve made $2M, and paid $800K in salaries. You write off 10% of that ($80K) and 10% of your other $1M in expenses ($100K). You will owe taxes on nearly $1.75M, but hey, you have $200K in the bank to pay your taxes thanks to cutting one or more salaries.
Maybe you cut half of your workers, and keep even more in the bank for those taxes.
Maybe you end some contractors early and rehire for the same work at lower pay.
Maybe you think you can replace some people with AI. That’s cheap and fast, though maybe not accurate or innovative. But why not… since it’ll cut expenses and help you through this situation.
The name of the game is to keep making the same revenue (or more revenue) while drastically cutting expenses so you have the money in the bank to pay these new, wildly higher taxes.
Why not cut office expenses?
Companies should cut office expenses. That would require re-embracing remote work, and shifting away from the mostly-disliked and not-disability-friendly “Return To Office” (RTO) initiatives. People who want to move to less expensive places and not near the office, will. Companies who wanted to pay less, will. More people would be able to accept that lower pay (if they wanted to) because they can make it work given the potentially lower cost of living far from the office.
Companies then pay less for offices and related expenses, further helping them with this awful section 174 situation.
I’m for people being paid more. I don’t want to see salaries and contractor pay cut. But since it is being cut anyway, my suggestion is to go back to embracing remote work, or as the Italians call it, smartworking.
Why not cut CEO, executive, or board member pay?
Another great question. If your average tech worker is paid $150K, and you want to cut let’s say millions of dollars, which is better in the short and long term? Cut 500 workers you probably really need, people who were overworked and hoping you’d hire more to help them? Or cut millions from C-level execs and others, who some would say should be showing their leadership through a voluntary pay cut?
If times are tough enough to have layoffs, leaders should be cutting their pay by millions. Need to cut lots of expenses but still need people to work on your mission-critical projects? Consider cutting C-level pay first.
We must also consider the long-term consequences. When we lay people off while companies are doing well — and execs aren’t cutting their pay much or at all — we teach workers that they are expendable and replaceable. We teach them that we will cut them at a moment’s notice for good, bad, transparent, or deceptive “reasons.”
Few companies announced that layoffs had anything to do with the new section 174 tax law changes.
Many companies announced layoffs not because they were struggling or in trouble. Many announced they were doing great, but needed to “rethink the future.” Some claimed they “overhired” even though laid off workers had no clue that their jobs or work were unimportant or unnecessary. Many of those projects continue, dumped on already overworked people.
We probably didn’t really overhire unless you define “overhiring” as “hiring more people than our accountants recommended once they thought about the new section 174 and what our tax burden would look like.”
Companies are already badly affected by this law, so badly that as of when I’m writing this in February 2024, Congress (in the USA) is considering a law to postpone the new section 174 changes for Americans (not for foreigners) until 2026. I’m not sure how you postpone something that’s already happening, but we’ll have to watch how this plays out.
Some people thought that the layoffs were fueled by greed. Some thought it was companies cutting bad workers or lowest performers. Some thought it was a move to boost stocks, which is strange since companies needing to lay people off doesn’t usually inspire consumer confidence.
While these are possible, or pieces in a larger puzzle, I get the feeling that for American companies, the new tax laws are the main impetus behind cutting good people in pretty good times.
Why wouldn’t this move more jobs to America and convince companies to hire fewer non-Americans?
Let’s do some math. Let’s say that I pay an American Engineer $150,000 per year. And let’s say that I found an equally-talented worker in another country for $100,000. That’s probably high, but we’ll use it as a math example.
I read that the 15-year amortization for foreigners is 3.33% per year for 15 years, and 50% in year 16, if you’re still in business.
Under the new section 174, in year 1, you can write off:
- $15K for the American worker, leaving you with a potentially taxable $135K.
- $3,330 for the foreign worker, leaving you with nearly $97K as potentially taxable.
If you’re a company interested in cutting costs, getting good workers cheaper, and you don’t care about where they are located (because they somehow don’t have to come into your Raleigh, North Carolina office like everybody else), the foreign worker is still the better deal, financially.
You would have around $97K versus $135K of potentially taxable profit. Now multiply that across every job you can shift from on-site Americans to off-site people outside of America.
I’m not making a statement about who should get jobs. That gets political fast. I’m only trying to envision this from the perspectives of the people who created this tax law change and the companies (and workers) affected by it. I don’t believe this change will move significantly more jobs with American companies to — or back to — America.
Conclusion: The tax law change didn’t do what it claimed, and caused many of our jobs to disappear or get re-hired at lower pay.
Get to know this tax law. It might explain a lot. A frightening amount of what’s going on sucks, but makes more sense once you think about the much higher taxes businesses have to pay thanks to these changes. This business tax law change certainly didn’t lower taxes for businesses, and was likely designed to offset a tax cut for the rich that was part of the same law.
I also can’t help but go a little deeper and ask this critical thinking question: why would an American President want to see companies doing R&D, technology, experimentation, and innovation hurt by significantly higher taxes? Why would that person want to see these companies lose workers, do less, or possibly close down? Who wins or is made stronger when American innovation is taxed so high that it becomes weaker?
Many American tech workers can’t find a job. The jobs that are offered want them in the office but pay way less than just a year or so ago.
I hope that these tax law changes can be undone ASAP. Not just delayed but undone. We now have over a year of proof of disastrous outcomes. What will be next is the larger economic slide when so many are out of work, spend less, or can’t cover normal human expenses.
Connect with us or learn more:
- CustomerCentricity.com — our website
- youtube.com/@cx-cc — YouTube channel
- patreon.com/cxcc — online community and free mailing list
- Articles on Medium or LinkedIn
- cxcc.to/ckys — “Customers Know You Suck,” my recent book on improving customer adoption, satisfaction, and retention
