The business use of websites is widespread, but IRS has not yet issued formal guidance on when Internet website costs can be deducted.
Fortunately, established rules that apply to the deductibility of business costs in general, and formal IRS guidance that applies to software costs in particular (the “software guidelines”), provide a taxpayer launching a business website with some guidance as to the proper treatment of the costs. Here is a brief discussion of some relevant principles:
The time for deducting website design costs (i.e., costs of the website's overall structure, functionality and appearance) depends on whether the costs are costs of “software” within the meaning of the “software guidelines.” Generally, the portions of the website's design that are produced from sophisticated programming languages (for example, the “C++” language widely used in website design) will qualify as “software.” On the other hand, there is some doubt as to the extent to which the portions of a design produced from HTML (hypertext markup language) will qualify as “software.”
Website design costs that are “software” costs. Some software design costs are deemed to be costs of “purchased” software—software that is either (1) non-customized software available to the general public under a non-exclusive license or (2) acquired from a contractor who is at economic risk should the software not perform. The entire cost of purchased can be deducted in the year that it is placed into service. The cases in which design costs are ineligible for this immediate write-off are (1) the few instances in which neither 100% bonus depreciation nor “section 179” small business expensing is allowed or (2) when the taxpayer has elected out of 100% bonus depreciation and has not made the election to apply “section 179” small business expensing. In those cases the design costs are amortized (ratably deducted) over the three-year period beginning with the month in which the website is placed in service. Note that the bonus depreciation rate will begin to be phased down for property placed in service after calendar year 2022.
If, instead of being purchased, the website design is “developed” (designed in-house by the taxpayer launching the website or designed by a contractor who is not at risk should the software not perform), for tax years beginning before calendar year 2022, bonus depreciation applies to the extent described above. Where bonus depreciation doesn't apply, the taxpayer can either (1) deduct the development costs in the year paid or incurred or (2) 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.
Website design costs that aren't costs of “software” are deductible in accordance with useful life. The time for deducting website design costs that are costs of portions of the design that aren't “software” depends on the expected “useful life” of these non-software portions of the design. Thus, these costs must be amortized over the number of years that it is expected that the non-software portions of the design will be used in the business (except if it is expected that these non-software portions of the design will have a useful life of no more than a year, in which case the costs can be currently deducted.)
Website content that is advertising is generally currently deductible; the treatment of other content costs will vary. Advertising costs are, generally, currently deductible. Thus, the costs of website content that is advertising are, generally, currently deductible. Website content that isn't advertising will be currently deductible, or amortized over a multi-tax year period, depending on its useful life.
The deductibility of some website costs that are business start-up costs is limited. Where website costs that would otherwise be currently deductible are paid or accrued before a business begins, the costs are deductible only upon the termination or disposition of the business, unless the taxpayer elects to (1) deduct up to $5,000 of the costs in the year that the business starts and/or (2) amortize the costs over a period of 60 months or more beginning with the month that the business starts.
The above principles, and others that effect the deductibility of website costs, suggest ways in which the individual or company launching the website can “take charge” of the treatment of website costs. For instance, an individual or company who contracts for a website design that qualifies as software, and who seeks the favorable tax treatment that applies to the costs of “developed” software, can, if acceptable as a business matter, include, in its written agreement with the developer/contractor, terms that will put the risk that the software won't perform on the individual or company. Another example of a way to manage the tax treatment of website costs is detailed, descriptive allocations of costs, both in contracts and in internal records.