OK, so based on this document (which I had not come across until now) I would say that the IRS is fairly clear that what I termed "Way #2" is the correct interpretation.
Which is, as many have noted, absolutely batshit crazy.
The only scenario that remains unaffected by this absolutely batshit crazy SNAFU is the case of a self-employed software developer who incurs zero costs related to their work. They simply collect all revenue as salary, pay normal tax on it, and they are done.
Anyone with any expenditures at all (contractors, employees, equipment) must treat these as capital expenditures, amortized over 5 (or 15 years for foreign based work).
It really is as bad as it could possibly be.
"(3) Software development. Section 13206(a) of the TCJA added new § 174(c)(3) to require that any amount paid or incurred in connection with the development of any software in taxable years beginning after December 31, 2021, be treated as a research or experimental expenditure (and thus an SRE expenditure to the extent paid or incurred by the taxpayer during the taxable year in connection with the taxpayer’s trade or business)."
and
".02 Requirement to capitalize and amortize SRE expenditures. Taxpayers are required to capitalize SRE expenditures (as defined in section 4.02(2) of this notice) and amortize such expenditures ratably over the applicable § 174 amortization period beginning with the midpoint of the taxable year in which such expenditures are paid or incurred."