Sorry, I thought that I had already posted this, but my newsreader was acting a bit off kilter. I have a software product that I have developed over the last 6 years or so. While I have been made offers on it before, a recent offer is attractive to me and before considering it, I trying to find out what kind of taxes I would be liable for. I've spoken with 4 CPA's today as well as the "complex tax issues" department at the IRS. 2 CPA's think that it would be taxed as ordinary income. 2 other CPA's as well as the IRS guy think it should be capital gains claimed on schedule D. While the product itself is software, it is not our actual business to design and sell software. This is a product that I developed (I personally have rights on it) and license for use by other companies. Having to pay 43% between federal and NC taxes makes the offer less than viable for me. Capital Gains taxes on the other hand, I could probably swing the deal. Any thoughts?
Without more background than you provide above, I can see at least 2 possible outcomes:
you sell the product outright, retaining no ownership or rights to the product or revenue it generates, then capital gains appears appropriate. Whether it's long or short term could still be an issue depending on when the software was first put into service.
if you license the software to others (whether individuals or companies), you'll have ordinary income. Whether you were (or believed your were or were not) in the software business before is irrelevant, you will be once you begin licensing the software to others. This is a very simple response based on limited facts provided. There are special (and potentially complex) rules for self-constructed assets and domestic production activities, none of which are discussed here. You clearly need guidance from a competent professional which is seems you're searching out.
I've seen this issue go both ways. It depends on facts and circumstances. Are you selling software? Are you licensing someone else to use it? Are you licensing someone else to sell it? Are you packaging it with another product or service?
First, thank you for your response. I know that is unfair and unrealistic to ask for actual advise on an open, unpaid forum. Factual information as you have provided is really appreciated.
-- Warm Regards, Lee
"Upon further investigation it appears that your software is missing just one thing. It definitely needs more cow bell..."
I think this is where there is some confusion, at least on my part. I wrote a business application (and have continued to refine it over the last 6 years) that I license to businesses in a specific sector to use. We don't sell software in the sense that we sell rights to it or ownership. We sell licenseses which give the licensee the right to use the software. We do not sell software in the sense that we are a contractual software house where customer pay us to write a software program for them and they keep the rights to the product. I'm not sure if this is even a valid distinction, but thought I should clarify.
Correct. We license the software to both end users directly (about 10% of our licenses are sold to end users) and through resellers (90%) who purchase the software licenses from us at a discount, market it up and bit and package it with a turnkey solution including hardware, support services, etc.
I'm not sure of this one. We allow resellers to resell software licenses as I explained above. If this is not the context that you referring to me, please let me know and I'll rephrase.
No. Although, there are other software products that we also license to customers (that I have written) that support the first product. As an example, there is an add-on module that customers can license that provides the main software with the ability to process credit cards. There's another that allows entriprise polling and agreggation of data from multiple stores and is an add-on module that can be licensed as well. Thanks for your input. As I mentioned in my response to San Diego CPA, I know it's impossible to give advise, but some direction through factual information is always appreciated. I would be just my luck to be in a situation that is apparently a gray area, LOL. My dilemna obviously not knowing how I would be taxed, should I accept the offer. As it stands right now, I receive about $120K in revenue after expenses to keep and develop the product. Further, the product is mature enough that I could actually cut down on the number of hours spent on adding new features, etc to
20-30 hours a week and coast for quite some time, I think. If the money that I would get up front is pared down to about 2-years worth of revenue after federal (35%) and NC taxes (8%), it hardly makes sense for me to sell, unfortunately. Thanks again!
You haven't specified exactly what you're selling.
If you're selling _everything_, the code, the copyrights, the buyer gets any future licensing or upgrade fees from the current licensees, etc. then I'd say it's capital gains. The less you sell, the more it looks like ordinary income. Seth
It would in fact be everything relating to that business. Software source, customer lists, upgrade revenue, intellectual rights, supporting products and their sources, website/domain name, the whole kit and kaboodle. We actually own two companies one of which, we would keep. The second company is unrelated to the first one that we are considering selling.
I'd like to make a couple of points which don't seem to have appeared up to this point.
First, over the previous six years, did you capitalize or expense your software development costs?
Second, and this is outside the tax part of the discussion, the valuation of your product in this potential sale seems pretty good. Normally software companies go for one to two times annual sales IIRC.
Then by analogy with a similar case in meatspace, I'd say it's capital gains. Warning: according to the same analogy, _next time_ it's ordinary income. The case I'm thinking of (which I read about many years ago and don't have a cite for) is a man who started a diner. After a few years, his wife got transferred to another city, so he sold the diner as a going business for a lot more money than he'd ever made running it. That was capital gains. In the new city, he opened a diner and ran it for a few years, then sold it. The IRS ruled (and I believe a court agreed) that he was now in the business of starting and selling diners, hence the proceeds were ordinary income. Seth
Coding the software is 98% of the costs. The development tools that I use, I use for all software development, not just this particular product. I have kept pretty decent records of my times spent coding the software which averages about 228 hours a month coding the software. I'm not sure if personal labor into the product counts, but even a mid level programmer can be expected to cost 80K a year between salary, company benefits, matching taxes, etc.
90% of our sales are through resellers. 70% of those sales are through "partner companies". Some are software companies that have modified their own software to integrate with ours which I wouldn't say locks them in, but makes re-tooling to another vendor a very expensive proposition. Some are just large volume resellers who private label our software as their own. It's a mid priced software package retailing for $695.00 per seat. Some customers require as many as 40 seats per location while the average sale to an end user averages about 3.2 seats sold (according to our records). The offers that we've received have come from our resellers, competitors and comapnies from parallel markets.
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