We spent a significant amount of money building our internal workflow automation, which we expensed on our tax returns. The buy-side Quality of Earnings auditors are refusing to capitalize these costs as an EBITDA add-back. How do we argue for this adjustment?

Question

Tyler Smith · Accepted Answer

Expensing software development costs on your tax returns is a smart cash-flow strategy because it minimizes your immediate tax bill, but it works against you during a sale. By expensing these costs, you have artificially lowered your historical EBITDA. During a Quality of Earnings audit, you must argue that these investments are non-recurring capital expenditures that should be capitalized and added back to your normalized EBITDA, which will instantly boost your valuation.

To win this argument, you must provide detailed, objective evidence that these costs were incurred to build a permanent, long term asset rather than standard ongoing maintenance. Under GAAP guidelines, specifically ASC 350-40, software development costs incurred during the application development stage should be capitalized. Present the auditors with your development roadmap, time-tracking records, and project scopes that prove your team was building new, proprietary workflow automation rather than simply fixing bugs.

Link this asset directly to your operational efficiency. Show how this internal automation has reduced your future headcount needs and permanently expanded your operating margins. Use your EOS Accountability Chart to show that the developers who built this system were operating in a specialized project capacity, not performing everyday IT operations. By presenting a professional, GAAP-compliant capitalization model, you can force the Quality of Earnings team to accept the add-back and preserve your multiple.