- Learn the deductibility of hardware vs software.
- Discover deductions associated with designing your own software.
- Find out how to deduct business website costs if you pay a third party to set up and run your website.
- Learn how to deduct website development costs as start-up expenses.
These days, most businesses have websites. But surprisingly, the IRS hasn’t issued formal guidance on when business website costs can be deducted. So, what do you do?
Fortunately, established rules that generally apply to the deductibility of business costs provide business taxpayers launching a website with some guidance as to the proper treatment of the costs. Plus, businesses can turn to IRS guidance that applies to software costs.
Do your business website costs include hardware or software?
Hardware versus software
Let’s start with the hardware you may need to operate a website. The costs fall under the standard rules for depreciable equipment. Specifically, once you put these assets into operation, you can deduct 100% of the cost in the first year you place them in service (before 2023). The 100% first-year bonus depreciation break allows this favorable treatment. Note: The bonus depreciation rate will begin to phase down for property placed in service after calendar year 2022.
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 2022, the maximum Sec. 179 deduction is $1.08 million, subject to a phaseout rule. Under the rule, the deduction phases out if more than a specified amount ($2.7 million for 2022) of qualified property is placed in service during the year.
There’s also a taxable income limit. Under it, your Sec. 179 deduction can’t exceed your business taxable income. In other words, Sec. 179 deductions can’t create or increase an overall tax loss. However, any Sec. 179 deduction amount that you can’t immediately deduct carries forward and you can deduct it in later years (to the extent permitted by the applicable limits).
Similar rules apply to purchased off-the-shelf software. However, software license fees are treated differently from purchased software costs for tax purposes. Annual payments for leased or licensed software used for your website are currently deductible as ordinary and necessary business expenses.
Software developed internally
If instead of purchasing a website, the taxpayer launching the website designs the website in-house (or a contractor designs the website), for tax years beginning before calendar year 2022, bonus depreciation applies to the extent described above. If bonus depreciation doesn’t apply, the taxpayer can either:
- Deduct the development costs in the year paid or incurred, or
- Choose one of several alternative amortization periods over which to deduct the costs.
For tax years beginning after calendar year 2021, generally, the only allowable treatment will be to amortize the costs over the five-year period beginning with the midpoint of the tax year in which the expenditures are paid or incurred.
If your website is primarily for advertising, you can currently deduct internal website software development costs as ordinary and necessary business expenses.
What if your business website costs involve paying a third party?
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.
Before business begins
Start-up expenses can include business website development costs. Up to $5,000 of otherwise deductible expenses that are incurred before your business commences can generally be deducted in the year business commences. However, if your start-up expenses exceed $50,000, the $5,000 current deduction limit starts to chip away dollar for dollar until it reaches $50,000. Above this amount, you must capitalize all of your start-up expenses and amortize them over 180 months, starting with the month that business commences.
We can help
Fiducial can help you determine the appropriate treatment of your business website costs. Want more information? Call Fiducial at 1-866-FIDUCIAL or make an appointment at one of our office locations to discuss your situation.