Website development costs.Many companies are spending large sums to develop and launch Websites. These costs include labor-related consultant and Web-page design fees, as well as software and hardware expenditures. The tax treatment of such costs may be mixed. The Code, regulations and proposed regulations appear to provide answers for hardware and software costs. However, to the extent labor costs are not for software development, the tax result is unclear. The IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. has issued no guidance on these costs. Many practitioners are simply writing these costs off as advertising. However, it is hard to imagine the Service not using INDOPCO, Inc. 503 US 79 (1992), to force capitalization capitalization n. 1) the act of counting anticipated earnings and expenses as capital assets (property, equipment, fixtures) for accounting purposes. 2) the amount of anticipated net earnings which hypothetically can be used for conversion into capital assets. of some of these costs. Websites come in many varieties, from providing information about the company and its products to an interactive store with hyperlinks to all sorts of information. The varieties can be categorized cat·e·go·rize tr.v. cat·e·go·rized, cat·e·go·riz·ing, cat·e·go·riz·es To put into a category or categories; classify. cat as follows: * Billboards. Many Websites are just display ads describing the company's products and services and contact information. * Catalogs. A site with detailed price and product information could be described as a catalog catalog, descriptive list, on cards or in a book, of the contents of a library. Assurbanipal's library at Nineveh was cataloged on shelves of slate. The first known subject catalog was compiled by Callimachus at the Alexandrian Library in the 3d cent. B.C. . These catalogs may be static or constantly updated, depending on how much a company wants to spend. * Database sites. A company can link a database to its Website. This link allows salespeople sales·peo·ple pl.n. Persons who are employed to sell merchandise in a store or in a designated territory. and customers with a password to check on product availability and can be designed to allow the development of customer profiles and mailing lists An automated e-mail system on the Internet, which is maintained by subject matter. There are thousands of such lists that reach millions of individuals and businesses. New users generally subscribe by sending an e-mail with the word "subscribe" in it and subsequently receive all new . With the right software, the accounting system can be updated for transactions on a site. * Virtual stores. Customers can view pictures and detailed information on products. Orders can be processed with a password or credit card. Software Costs The portion of Website development costs that can be allocated to software is recoverable over various periods, depending on several factors, including whether it is purchased or self-developed. Exhibit 1 is a diagram of the rules under the Code and proposed regulations. [Exhibit 1 ILLUSTRATION OMITTED] If software is purchased with a trade or business, is not available to the public and is not substantially modified, the cost will be amortized over 15 years as a Sec. 197 intangible (self-created intangible). If, however, software acquired with a business is publicly available or substantially modified, it is treated as purchased software. Treatment of costs of purchased software depends on whether the costs are separately stated. If a cost is included as part of a hardware cost, it is depreciated Depreciated may refer to:
Software not acquired with a business is treated as purchased software, unless the taxpayer bears the risk of functional utility. In that case, it is categorized as "self-developed software," with multiple cost recovery options. Self-developed software may be expensed under Sec. 174(a), amortized over 60 months under Sec. 174(b) or amortized over 36 months under Prop. Regs. Sec. 1.167(a)-14(b). Nonsoftware Costs The tax treatment of consulting fees and other labor costs that cannot be allocated to software development is unclear. Recent statements and actions by the Service give some cause for concern. The IRS view may depend on the function of the Website. If the site simply performs the function of a catalog or billboard, the Service may analyze the costs in terms of advertising. This would appear to be good news, as normal product or goodwill advertising is deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). . However, there are at least two uncertainties that could affect whether the IRS is willing to conclude that a Website is normal product advertising. First, it may attempt to capitalize Website costs under the analogy that the site is functioning as a catalog. The Service has had mixed success with capitalizing catalog costs; compare Best Lock Corp., 31 TC 1217 (1959), with E. H. Sheldon, Co., 214 F2d 655 (6th Cir. 1954). It would seem logical to conclude that such an IRS position would more likely be sustained if the site were an infrequently in·fre·quent adj. 1. Not occurring regularly; occasional or rare: an infrequent guest. 2. updated static catalog, rather than a constantly updated dynamic catalog. The other concern related to advertising is whether the Service will continue to distinguish between the costs of developing an ad campaign and the costs of executing it. In RJR Nabisco RJR Nabisco, Inc., was an American conglomerate formed in 1985 by the merger of Nabisco Brands and R.J. Reynolds Tobacco Company. RJR Nabisco was purchased in 1988 by Kohlberg Kravis Roberts & Co. in the second largest leveraged buyout in history, adjusted for inflation. , Inc., TC Memo 1998-252, the IRS argued that campaign development costs created long-term capitalized benefits. The Tax Court disagreed and allowed a deduction. The Service recently announced it would not follow that decision (IRB IRB See: Industrial Revenue Bond 1999-40). The IRS could use the same reasoning to require capitalization of a campaign on the Web. Developing a Website that is a virtual store (rather than just a catalog) may present a different challenge. The Service could take the position that the virtual store is a new channel of distribution. Earlier, the IRS had a Tax Court victory overturned on appeal when it attempted to capitalize the costs of a channel of distribution (Briarcliff Candy Corp., 475 F2d 775 (2d Cir. 1973)). Taxpayers, however, should not be too sanguine sanguine /san·guine/ (sang´gwin) 1. plethoric. 2. ardent or hopeful. san·guine adj. 1. Of a healthy, reddish color; ruddy. 2. about using Briarclff to justify deductions for developing new channels of distribution. Caution is advised because the Second Circuit used the "separate and distinct asset" test rejected by the Supreme Court in INDOPCO. Recent Field Service Advice 9999-9999-65 reflects the Service's intention to closely monitor product, market and channel expansion costs for possible capitalization. Another approach the IRS could use to disentangle software from other costs is to carve out to make or get by cutting, or as if by cutting; to cut out. - Shak. See also: Carve "content" costs. For example, graphics that generate fees may not be considered part of the cost of software. Software is the basic architecture of a Website. The content, on the other hand, may be easily changed without affecting the architecture. The content may be a catalog or it may generate fees. The Service could require capitalization of fee-generating content, particularly if the content is not changed frequently. The IRS may be delaying a response on the deductibility of Website costs (as well as other e-commerce issues) while the Advisory Commission on Electronic Commerce deliberates. The Commission's recommendations, however, were to be submitted to Congress no later than April 2000. FROM LARRY MAPLES, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , DBA, AND MELANIE J. EARLES, CPA, DBA, DEPARTMENT OF ACCOUNTING & BUSINESS LAW, TENNESSEE TECHNOLOGICAL UNIVERSITY Tennessee Technological University, popularly known as Tennessee Tech, is an accredited public university located in Cookeville, Tennessee, a small city approximately seventy miles (110 km) east of Nashville. , COOKEVILLE, TN (NEITHER ASSOCIATED WITH BDO SEIDMAN BDO Seidman, LLP is the United States arm of BDO International, one of the largest accounting firms outside of the Big Four. History BDO Seidman, LLP was founded as Seidman and Seidman in New York City in 1910 by Maximillian L. Seidman. ) |
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