Website development--how to account for set-up, installation

and maintenance costs.

What are the likely Federal income tax consequences of Website development costs? Important
factors include what was purchased, how it was delivered and invoiced, how it will be used, and
exactly what has been developed or acquired. In nearly all cases (and in its simplest form), a Website
consists of a combination of computer hardware, computer software and Internet access. Costs
associated with each of these elements can (and do) produce different tax effects, depending on the
nature, extent, form and substance of the separate steps and underlying transaction(s).
Hardware Costs
Usually, the first step in a Website design is the acquisition of appropriate computer hardware or
Web server. This is accomplished through direct purchase of the necessary assets or outsourcing the
needs through a lease or right-to-use transaction. For tax purposes, the outright purchase of
computer hardware will (almost always) require capitalization and recovery of cost through
depreciation deductions. The recovery period for such property is five years. On the other hand,
lease payments for the use of such property are traditionally deductible as ordinary and necessary
expenses.
Software Costs
The next step in the Website process is the purchase or development (or combination thereof) of
computer software, required to operate the Web server and to create the actual Web page. Special
code (e.g., HTML) must be created, so that the Website can be accessed by a user's browser to
display graphics, text, links and other applications. In this regard, the Website's software needs can
be broken down (for tax purposes) into development costs and acquisition costs. While the general
rules for software costs tend to follow the tax treatment for hardware costs, there are some subtle
(but important) differences.
Other Costs
In addition to hardware and software needs and costs, most Website development or acquisition will
require consulting, testing, training and other similar costs attendant to the hardware and software.
In most cases, outside third-party specialists perform these types of activities and bill the Website
purchaser for such services. Other types of costs may include investigatory expenses,
integration/facilitation, implementation and performance analysis. Most of these charges will be
separately incurred and stated, even if the same person or entity provides the hardware and/or
software.
Standards Applied
The IRS has not issued definitive authority on the proper tax treatment for costs associated with
Webpage and Website development. Taxpayers must rely by analogy on similar transactions for
which there is specific authority, or apply general concepts to particular facts to arrive at a
reasonable filing position.
With any business expenditure, the question is whether the costs are incurred and result in a
"significant long-term benefit" to the company. The creation of a new, distinct asset is not required,

only a significant long-term benefit. The Service has not specifically applied this standard to
software development or acquisition costs. Rev. Proc. 69-21 deals with the current deductibility of
software development costs in light of research and development expenditures, Rev. Proc. 97-50
applied Rev. Proc. 69-21 in the context of Y2K costs, and whether such costs were currently
deductible or had to be capitalized. Applying the reasoning of this procedure is problematic, as it
attempts to classify computer software development, purchase and leasing transactions in very
broad terms. Such circumstances, however, likely do not reflect today's business environment or the
specific transactions involved in developing or acquiring a Website.
Another possible source of authority would be specific rules for purchased intangible assets (e.g.,
goodwill, covenants not to compete, etc.). Purchased software can be included in this category if it is
not acquired as part of a trade or business, but it must be capitalized and amortized over 36 months.
The problem with this basis is that it may not adequately address the purpose and nature of the
applied software as a Website marketing or sales tool.
If nothing else, a good argument can be made that the appropriate test to apply is whether the
Website costs are simply "ordinary and necessary" (thus, currently deductible) or result in a
significant long-term benefit (thereby requiring capitalization and depreciation).
Lastly, it is very important to ascertain (and document) the fundamental use of the completed
Webpage and site. It is possible the primary purpose could range from solely "e-tailing" order taking,
to technical database access, to simply providing links to related sites or any combination. Because
the tax treatment of the costs associated with the Website can differ based on the site's use, it is
important to document use and intent.
Summary
Understanding that all factual situations are different and may lead to opposite conclusions, the
following general rules should apply to most Website development costs. Purchased computer
hardware should be capitalized and depreciated over five years. Leased hardware should be
expensed as incurred, like other rental payments.
Software acquired or developed (i.e., off-the-shelf software with custom modifications) may be
currently deductible if ordinary and necessary. Factors that tend to support a current deduction
include use of the site for marketing and advertising, order taking or other "normal" business
purposes. The premise here is that the Website is simply providing electronic marketing, sales,
advertising and other general and administrative expenses that were previously not performed
electronically. It follows, therefore, that there should be no difference in tax treatment based solely
on the difference in the medium to which the expenses relate.
Website development costs incurred in a "start-up" or business expansion situation should also be
currently deductible, although treating such costs as start-up costs amortizable over 60 months, may
not be an unreasonable position. Technically, software development costs are excluded
(administratively) from the definition of start-up costs and should be currently deductible, in total, in
the year in which incurred.
Finally, based on several recent court cases, it is unlikely that "typical" Website development costs
should qualify for the research and development credit. This is not to say, however, that a credit
would not be available under all circumstances. In fact, it is possible that sound arguments could be
made to exclude Website costs from "internal-use" software as that test is applied for research credit
purposes.

Conclusion
In the absence of clear authority, reasonable arguments are available for currently deducting most
Website development costs. Taxpayers should keep detailed records of all expenses during each step
of the process. Additional documentation pertaining to actual and intended use of the Website,
explicit invoice descriptions (especially for the "Other Costs" described above) and detailed analysis
of each step in the process, is important.
FROM TOM DELONG, CPA, ZAINER RINEHART CLARK DFK, SANTA ROSA, CA
Philip E. Moore, CPA, MBA Brown, Dakes & Wannall, P.C. DFK International Fairfax, VA
http://www.thefreelibrary.com/Websitedevelopment--howtoaccountforset-up,installationand...-a0662
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