Year 2000 cost guidance.

Rev. Proc. 97-50 provides that taxpayers may use the provisions of Rev. Proc. 69-21, if certain requirements are met, to recognize costs incurred to enable computer software to recognize year 2000 and beyond.

Many computer systems may fail to operate or may operate improperly due to a failure to recognize the year 2000 as the result of a two-digit, rather than a four-digit, date field. Taxpayers are incurring significant costs ("year 2000 costs") to (1) manually convert existing software, (2) develop new software to replace existing software or (3) develop or purchase tools to assist in converting existing software to remedy the year 2000 problem.

Rev. Proc. 97-50 provides that taxpayers meeting the guidelines of Rev. Proc. 69-21 may use that procedure to recognize year 2000 costs for tax purposes. Specifically, taxpayers developing software (including converted software) may treat the costs in accordance with Section 3 of Rev. Proc. 69-21; taxpayers incurring purchased software costs may treat them in accordance with Section 4 of Rev. Proc. 69-21; taxpayers incurring leased software costs may treat them in accordance with Section 5 of Rev. Proc. 69-21.

In general, Rev. Proc. 69-21 defines computer software to include "all programs or routines used to cause a computer to perform in a desired task or set of tasks and the documentation required to describe and maintain those programs." Under Section 3 of Rev. Proc. 69-21, costs of developing software resemble the type of expenditures to which Sec. 174 may apply, such that the IRS will not disturb a taxpayer's treatment of software development costs when such costs are consistently treated as a current expense under Sec. 174(a) or capitalized and amortized over a period of five years (or the useful life, if less than five years) beginning from the date the development is completed in accordance with Sec. 174(b).

Under Section 4 of Rev. Proc. 69-21, costs of purchased software are capitalized and depreciated if such costs are treated as part of the cost of the hardware. Purchased software costs that are separately stated (i.e., not part of the cost of the hardware) are treated as an intangible asset and capitalized and amortized over 36 months in accordance with Sec. 167(f)(1). (Note: Rev. Rev. Proc. 69-21 provides for an amortization period of five years or the useful life if less than five years.)

A taxpayer's treatment of leased software costs as a current expense consistent with Regs. Sec. 1.162-11 will be respected by the Service under Section 5 of Rev. Proc. 69-21.

Taxpayers not currently applying the provisions of Rev. Proc. 69-21 in determining the proper tax treatment for year 2000 costs may request to change their method of accounting for such costs. Rev. Proc. 97-50 provides that taxpayers may obtain automatic consent for a change to a method consistent with Rev. Proc. 69-21 for year 2000 costs by following the provisions of Rev. Proc. 97-37.

FROM DIANE P. HERNDON, WASHINGTON, D.C.