Calvin H. Johnson is Professor of Law, University of Texas. The author wishes to thank Victor Thuronyi, Kristin Hickman, Daniel Markovits, David Cameron, Joe Mikrut, John Golden, Robert M. Brown, and Les Schneider for helpful comments on a prior draft without binding them to the conclusions.

Under current law, a taxpayer may deduct the costs of development of computer software. Software development is also eligible for a 20 percent tax credit, an exclusion of 9 percent of revenue, and expensing to purchasers of software. With all combined, an investment can lose more than 7 percent 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 extending over the remaining tax life. It would replace the 20 percent 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, a collaboration by tax professionals to develop and perfect proposals to help Congress when it needs to raise revenue. Shelf Project proposals are intended to raise revenue without raising tax rates, because the best systems have taxes that are unavoidable to reach the lowest feasible tax rates. Shelf Project proposals defend the tax base and improve the rationality and efficiency of the tax system. Given the calls for economic stimulus, some proposals 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, Dec. 10, 2007, p. 1077, Doc 2007-22632 [PDF], or 2007 TNT 238-37 .

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.

Capitalize Costs of Software Development