Section 199 Domestic Production Tax Credit

We discussed this in Episode 4 of the podcast but we should probably touch on it again. If you missed it, software companies can save a very substantial amount of money on their taxes as they’re technically domestic manufacturing.

There’s some details at the link below though I highly recommend you talk to your accountant first before just taking tax credits :smile:


Oh, I was spurred on by this nice tweet from @robwalling. Still time for the rest of you to save a few thousand bucks!

I noted this with interest when Rob mentioned it on Twitter. Very interesting!

Does anyone know if developing software for someone else (e.g. web developers who produce a finished website as an end product) can/should claim this deduction?

(talk to an accountant!) I believe that does not qualify. Consulting and such is not covered. You have to be selling software.

Interesting. Going to inquire with @taxgrl about this now!

You don’t qualify for the deduction unless you pay W2 wages.

Sounds right. This is an entirely different thread topic but I really hope most of you making decent money are paying yourself W2 wages [ian]feels scared to know the answer to this[/ian]

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Ok, I’ll bite @ian. I’m new to this. Why should I be paying myself W2 wages?

Because if you don’t, someday the gov will take a look and say you should have been and hit you with a giant tax bill for all the payroll taxes you were skipping out on by not doing it. Plus fees, penalties, etc.

You generally have to pay yourself a wage that’s at fair market value for your services. Which I always find a little weird because you own the thing and do everything and all that.

Another thing to note as @robwalling just reminded me on twitter. You’ll want to check previous years as well. Often it’s enough money that you’ll want to re-file those and get a refund.

There’s also a R&D tax credit that I’ve used in the past. Building software for external customers may be eligible - and it was for us making Facebook games in the USA.

This is a little more complicated to calculate, as there’s lots of stuff that isn’t eligible that you need to filter out, but can be worth pursuing.

@ian’s comments are correct if your company is organized as an S-corporation or corporation. However, if your company is registered as a partnership or LLC (unless you elected to be taxed as a corp or S-corp), you are actually not allowed to pay yourself W-2 wages.

If you would qualify for a decent deduction, that is something to consider when determining the structure of your business.

If you are indeed an S-corporation, and are not paying yourself a fair wage, keep in mind this is something the IRS is cracking down on lately. S-corporation shareholders do not pay self-employment tax on their share of the income. By not paying yourself wages, you’re escaping Social Security and Medicare entirely, which is a form of tax evasion.

Partnership partners, LLC members and sole proprietors all pay self-employment tax on their share of the company income, so there are no issues with those types of companies not paying wages.


Note also that if your company is a partnership or LLC, and for some reason you want to receive W-2 wages, you can use a payroll outsourcing company, where you are paid as an employee of the payroll company, and your company pays the payroll company for your services.

On a related note, is there a tax guide of some sort for first timer software entrepreneurs? The most I’ve done is use Turbotax. I’d imagine a tax consultant can answer very detailed questions. What I’d like is a “here is the rules governing taxes for businesses, and to maximize profit, you should do X, Y, and Z, and avoid A, B, C because this and that.”

I’m sure there’s some ones out there, maybe somebody can post one. However, the real answer is you must go to an accountant. I do mean MUST. If you don’t have $500-$1000 to get an accountant from day 1 to incorporate you and all that you’re probably not ready to be in business.

Even accountants make mistakes (like how many of them don’t know about this section 199 credit for software), but at least you’ll know things are properly setup legally. It’s also good to have an established relationship for when something comes up and you need to ask a question.


Thanks! Looks like from the posts below that since I’m an LLC that it isn’t a big deal, but good thing to remember down the road.

This is more for the Ian’s in the room then for people without employees, but if you’re operating at a certain scale, you should also ask your accountant about the R&D tax credit. It has crazy recordkeeping requirements, but suffice it to say that, in software, substantially all of your engineering employees are 100% allocable as research expenses. You basically get a credit for (I think) 3% of their total salaries, which can work out to A Lot Of Money ™.

The quick snap-judgement line is “Call your accountant and talk about this TODAY if you make more than $1 million in sales a year.”

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Interesting. I’m definitely going to ask about that (great, more recordkeeping!).

Awesome! Yeah, the last few years I’d classify the amount of money we save as shocking.

What if you are paying contractors (as 1099s)? I’m an S-corp and I pay W-2 wages to myself, but 1099s to my contract developers. Does that mean I don’t qualify?