It’s not surprising, given the complexity of our tax rules, that developing and maintaining a Website involves a variety of costs that should be identified and accounted for separately. Some costs are deductible immediately as expenses, some are so-called “capital expenses” that can only be deducted over a period of time and some might even produce tax credits—directly reducing the ski resort operation’s tax bill.
Few Ground Rules Exist
Since 1969, neither lawmakers nor the Internal Revenue Service have addressed the question of deductions for software. That means there aren’t any regulations describing how Web development costs should be treated, but there are precedents to produce legitimate deductions.
Among the questions that can’t be answered, however, is whether a resort’s foray onto the Internet constitutes a new business. A distributor who opens a retail outlet for the same type of goods it has distributed for years, for example, is considered to have opened a new business with startup costs that can be capitalized and written-off over a period of years. But the expenses of a retailer opening another retail outlet are considered “ordinary and necessary” and are immediately deductible on the annual return.
Although the IRS has not yet outlined the specific tax treatment for Web-development costs, clues exist elsewhere. And they provide plenty of examples of proper tax treatments to get substantial tax savings.
Website Software
Software is considered to be an “intangible asset” of the ski resort or other ski-related business. Although the tax rules for purchased software are pretty straightforward (it is usually depreciated over three-years beginning in the month it’s first used), software developed in-house creates more questions. The expenses involved (whether for a resort’s own use or for sale to others) can be deducted currently or amortized over five years.
But is a Web-related expenditure really strictly for software? Here’s where it gets interesting: Costs for software, graphics and content each receives its own, unique tax treatment. And differentiating between the three can be a real challenge.
Consider the imaginary case of White Snow Resort, Inc. They created a Website primarily for advertising purposes, but they also have the capability to allow visitors to book reservations online. The Website uses dozens of digital photos, some of which are virtual reality shots allowing viewers to more fully experience the resort’s facilities. Thousands of dollars go into the creation of these photos. In addition, the ski resort paid a designer to create the look and feel of the Website, including the page layouts and navigational buttons.
The cost of those page layouts and navigational buttons would probably be considered by the IRS to be part of the software costs while charges for the photos would not. The reason? Back in 1969, when the basic rules for software development and sale were created, graphics, sound, video and content were not considered and didn’t register on the radar screen as part and parcel of software. Today, however, those elements are almost always included in the package.
Battling the Elements of the Web
Certain graphics that are part of the content of the site are used primarily as advertising and are deductible as such. However, for a number of Websites—most notably adult-content Websites—graphics are assets that generate fees. It is questionable whether the costs related to these types of graphics are tax deductible and, if they are, over what time period. Are those digitized photos on the White Snow Website considered “artwork,” that is generally not tax deductible?
Strangely, content is not considered to be integral to the development of a Website the way software and graphics are, and is best defined as what is delivered by a Website. Software might be viewed as the permanent part of the site where the content is the material that can be changed without affecting the site’s basic architecture. Because of that, its tax implications are different.
Deductions of the costs of developing non-advertising content—content that is clearly not advertising, such as advice that attracts surfers—have not been nailed down even though considerable costs are incurred.
On the one hand, there are a number of authorities backing the assumption that literary content developed for a Website can be deducted currently. On the other hand, a 1992 decision by the U.S. Supreme Court provided a general rule that costs resulting in benefits extending beyond the current year should be capitalized. Since there’s no clear ruling in this area, interpretation is left up to the taxpayer. Auditors might challenge the selected treatment, but thus far, differences have been worked out outside the courts.
Another conundrum open to interpretation are the expenses involved with securing domain names. Today, more and more ski resorts must pay to acquire an already registered domain name and the rising prices commanded by domain names that change hands begs for a tax deduction. Once again, the issue is not cut-and-dried.
It might be possible to apply section 197 of the U.S. Tax Code, which deals with the acquisition of an intangible asset, in order to assign a 15-year life span to the resort Website domain name. Assigning that life-span makes it feasible to capitalize costs over time. But if an auditor disagrees, you won’t be able to deduct the cost of the domain name until it is sold or abandoned.
Any taxpayer who can justify their treatment of expenses and who treats those expenses in a consistent manner from year-to-year will normally get the approval from the IRS. In fact, it’s possible the IRS would permit some or all Website development costs to be considered for the ultimate reward—a tax credit for research and experimentation.
Research and Experimentation
There still exists in our tax rules a credit for research and experimentation costs. Closely watched and very narrow in scope, this tax credit is available, in some instances, for “internal-use software.”
Generally, internal-use software is defined as software used primarily for in-house purposes like bookkeeping, inventory management or order processing. Some of it, like that used for order processing, is sometimes used by customers to book reservations online, but is still considered internal-use software.
Though still currently on the books, the research and experimentation tax credit is under the gun from the IRS, which recently proposed regulations that would, in the view of many experts, thwart Congressional intent and make it impossible for anyone to claim the credit. Some say that IRS agents are already disallowing the credit.
Fortunately, aside from the controversial research and experimentation tax credit, most of the costs of developing and maintaining a Website for your ski resort or business are tax deductible. The argument for breaking down those costs in order to qualify for the tax deductions that will benefit your business the most is bolstered by the lack of specific rules over what is deductible, depreciable and not deductible at all.
Mark Battersby is a freelance writer, lecturer and corporate advisor specializing in business taxes and other financial matters.
