Back to Normal: Section 174 Finally Fixed

Escaping the Tax Trap - Update September 2024

On July 4, 2025, the U.S. government “fixed” the tax law known as Section 174, which between 2022-2024 had required all companies to capitalize “the development of any software.” (We wrote about it in 2023 and 2024.)

You should pay attention to this as a SaaS operator in two scenarios: One is if you’ve ever paid income taxes; there could be a near-term cash impact. The other is if you might exit and have the potential for Qualified Small Business Stock (QSBS) tax exemption; there could be a huge, possibly once-in-a-lifetime opportunity to optimize.

However, the details of the fixed law, Section 174(A), are complex. Rather than try to cover it in full detail, we decided to simplify this as a choose-your-own-adventure type guide. Just pick the statements that apply to your SaaS company below:

Did your SaaS company begin business after January 1, 2025?

Yes: Congratulations! You can ignore all of this. It’s back to how it was before everything got broken. Software development is an operating expense. STOP HERE.

No: You should have been capitalizing software dev. GO ON to (2) below.

Did you actually do any capitalizing of software development in 2022-2024?

Yes: SKIP to (4) below.

No: GO ON to (3) below.

You didn’t capitalize your development. Did your SaaS company always have a net income loss, and expects a loss in 2025?

Yes: Congratulations(?) You probably never paid income tax, and this all “comes out in the wash.” (You might want to re-file later, but as a low priority – no cash impact today.)

No: Oops! Call your accountant. It’s probably going to be OK – meaning no cash impact from the “fix” – but you might have underpaid taxes during 2022-2024.

Either way, SKIP to (5) below.

Will/did your SaaS company have a profit in any year 2022-2025?

Yes: Likely Cash Impact. Congrats on the profit! With the fix, you can expense everything you previously capitalized on your 2025 return, which should reduce your income tax. Is your revenue below $31 million?

Yes: Likely Immediate Cash Impact. You can also go back and re-file your 2022-2024 returns, taking the software expense, for an immediate refund.

No: Congrats on the great revenue as well!

No: You can expense any capitalized software, but it won’t likely have a cash impact.

Either way, SKIP to (5) below.

What are your total Gross Assets, excluding any capitalized software assets?

More than $75 million: You are too big to qualify for QSBS, so it doesn’t matter. STOP.

Less than $75 million: Are you a domestic “C” corporation?

No: Don’t qualify for QSBS, so it doesn’t matter. STOP.

Yes: Important Exit Planning Issue! QSBS is probably the single most important tax issue for any SaaS entrepreneur or shareholder, as it can result in tax-free earnings at exit. If there is any possibility that the capitalized software assets could put you over the $75 million gross asset threshold, it is vitally important that you consult your tax advisor and see how you can get the asset/expense treatment changed in advance of a potential exit event. STOP.

(Some caveats: the above assumes your tax year is the calendar year; things get more complicated if your fiscal / tax year crosses the Jan 1 boundary. And, it should go without saying that a tongue-in-cheek, choose-your-own-adventure is not professional advice, which you should seek if applicable. We do hope, however, that it’s good for a chuckle, and informs some folks about a possible cash-impacting refund situation or a QSBS concern down the road.)

Randall Lucas

Managing Director, SaaS Capital

SaaS Capital® pioneered alternative lending to SaaS. Since 2007 we have spoken to thousands of companies, reviewed hundreds of financials, and funded 100+ companies. We can make quick decisions. The typical time from first “hello” to funding is just 5 weeks. Learn more about our philosophy.

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