New guidelines on tax accounting for software costs.

The IRS has updated its guidelines on accounting for software development costs. Rev. Proc. 2000-50 supersedes the guidelines for software costs provided in Rev. Proc. 69-21, and modifies Rev. Proc. 99-49's procedures for obtaining an automatic consent to a change in accounting method and Rev. Proc. 97-50's guidelines on the costs of converting or replacing computer software to be Y2K compliant. The new guidelines are effective for tax years ending on or after Dec. 1, 2000, and cover the costs to develop, purchase, lease or license computer software.

Under Rev. Proc. 2000-50, costs for developing software for a developer's own use or for sale or lease to others may continue to be treated as current expenses under rules similar to Sec. 174(a). Developers may also continue to treat the costs as capital expenditures amortizable over 60 months from completion of development under Sec. 174(b) or over 36 months from the date placed in service under Sec. 167(f)(1).

For costs associated with purchased software, the Service will not challenge the treatment of costs included in the capitalized and depreciable cost of hardware. In addition, as long as the rules under Sec. 167(f)(1) are followed, the IRS will not challenge the treatment of costs separately stated. Under Regs. Sec. 1.167(a)-14(b)(1), costs are consistently treated as capital expenditures for an intangible asset and are recovered by amortization deductions ratably over a 36-month period. Also, the Service will not disturb a rental deduction under Regs. Sec. 1.162-11 if a taxpayer leases or licenses computer software.

Although Rev. Proc. 2000-50 is not markedly different from Rev. Proc. 69-21, it does clarify some guidelines and include others. For example, the term "computer software" is defined as "any program or routine ... that is designed to cause a computer to perform a desired function or set of functions, and the documentation required to describe and maintain that program or routine." Likewise, the term "program" or "routine," for purposes of defining computer software, has been described to be any sequence of machine-readable code.

The definition of computer software has been expanded to include all forms and media in which the software is contained, whether written, magnetic or otherwise. Moreover, it includes any incidental and ancillary rights necessary to effect the acquisition of the title to, the ownership of or the right to use the computer software, and that are used only in connection with such software. However, the definition has been modified to exclude any data or information base described in Regs. Sec. 1.197-2(b)(4) (e.g., data files, customer lists or client files), unless the database or item is in the public domain and is incidental to a computer program.

Although the new guidelines define computer software in terms of machine-readable code and related documentation, Rev. Proc. 2000-50 is consistent with Rev. Proc. 69-21 in describing the process of software development in terms of "all costs properly attributable to the development of software." In addition, it applies to all computer software costs, except any computer software subject to amortization as an "amortizable Sec. 197 intangible," or to costs that a taxpayer treated as a research and experimentation expenditure under Sec. 174.

Finally, any change in a taxpayer's treatment of costs to develop, purchase, lease or license computer software to a method described in Rev. Proc. 2000-50 is an accounting method change to which Secs. 446 and 481 apply. However, a change in useful life under one of the amortization methods described in the revenue procedure is not a change in accounting method. In other words, if a taxpayer capitalizes costs under a Sec. 174(b) method, it may choose a useful life of 60 months, 36 months or anything in between. If a taxpayer wants to make a change, it must follow the automatic change in accounting method procedures in Rev. Proc. 99-49, with certain modifications. The modifications are (1) a requirement that Form 3115, Application for Change in Accounting Method, include the statement, "Automatic Change Filed Under Section 8.01 of Rev. Proc. 2000-50" and (2) if the taxpayer is changing to a Sec. 174(b)-like method, a requirement that Form 3115 include a statement of the amortization period chosen (e.g., a 36- or 60-month period). Note: This is a considerable improvement over the prior rules, in which the treatment of non-Sec. 174 software development costs could be changed only with a nonautomatic filing under Rev. Proc. 97-27.

FROM KURT RANDALL, CPA, DENVER, CO