The business use of websites is widespread. But surprisingly, the IRS hasn’t yet issued formal guidance on when business website costs are deductible.
Fortunately, established rules that generally apply allowing for website cost tax deductible, and IRS guidance that applies to software costs, provide business taxpayers launching a website with some guidance as to the proper treatment of the costs.
Let’s start with the hardware you may need to operate a website. The costs involved fall under the standard rules for depreciable equipment. Specifically, once these assets are up and running, you can deduct 100% of the cost in the first year they’re placed in service (before 2023). From the new bonus depreciation rules, this favorable treatment is allowed under the 100% first-year bonus depreciation break.
In later years, you can probably deduct 100% of these costs in the year the assets are placed in service under the Section 179 first-year depreciation deduction privilege. However, Sec. 179 deductions are subject to several limitations.
For tax years beginning in 2020, the maximum Section 179 deduction is $1.04 million, subject to a phaseout rule. Under the rule, the deduction is phased out if more than a specified amount of qualified property is placed in service during the year. The threshold amount for 2020 is $2.59 million.
There’s also a taxable income limit. Under it, your Section 179 deduction can’t exceed your business taxable income. In other words, Section 179 deductions can’t create or increase an overall tax loss. However, any Section 179 deduction amount that you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable limits).
Similar rules apply to purchased off-the-shelf software. However, for tax purposes the IRS treats software license fees differently from the costs of purchasing software. Payments for leased or licensed software used for your website are currently deductible as ordinary and necessary business expenses.
An alternative position is that your software development costs represent currently deductible research and development costs under the tax code. To qualify for this treatment, you must pay-off or incur the costs by December 31, 2022.
A more conservative approach would be to capitalize the costs of internally developed software. Then you would depreciate them over 36 months.
If your website is primarily for advertising, you can also currently deduct internal website software development costs as ordinary and necessary business expenses.
Some companies hire third parties to set up and run their websites. In general, payments to third parties are currently deductible as ordinary and necessary business expenses.
Start-up business expenses can include website development costs. One can incur up to $5,000 of otherwise deductible expenses before the business commences, and is generally deductible in the year the business commences. However, if your start-up expenses exceed $50,000, it will start to chip away the $5,000 current deduction limit. Above this amount, you must capitalize some, or all, of your start-up expenses and amortize them over 60 months, starting with the month that business commences.
We can determine the appropriate treatment of website costs for federal income tax purposes. Contact us if you have questions and for all your accounting solutions.