Most businesses have websites today. Despite their widespread use, the IRS hasn’t issued formal guidance on when website costs can be deducted.
But there are established rules that generally apply to the deductibility of business expenses and provide business taxpayers launching a website with some guidance about proper treatment. In addition, businesses can turn to IRS guidance on software costs. Here are some answers to questions you may have.
What are the tax differences between hardware and software?
Let’s start with the hardware you may need to operate a website. The costs fall under the standard rules for depreciable equipment. Specifically, for 2024, once these assets are operating, you can deduct 60% of the cost in the first year they’re placed in service. This favorable treatment is allowed under the first-year bonus depreciation break.
Note: The bonus depreciation rate was 100% for property placed in service in 2022 and was reduced to 80% in 2023, 60% in 2024 and it will continue to decrease until it’s fully phased out in 2027 (unless Congress acts to extend or increase it).
Alternatively, you may be able to deduct all or most of these costs in the year the assets are placed in service under the Section 179 first-year depreciation deduction privilege. However, Sec. 179 deductions are subject to several limitations.
For tax years beginning in 2024, the maximum Sec. 179 deduction is $1.22 million, subject to a phaseout rule. Under the rule, the deduction is phased out if more than a specified amount ($3.05 million in 2024) of qualified property is placed in service during the year.
There’s also a taxable income limit. Under it, your Sec. 179 deduction can’t exceed your business taxable income. In other words, Sec. 179 deductions can’t create or increase an overall tax loss. However, any Sec. 179 deduction amount that you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable limits).
Similar rules apply to purchased off-the-shelf software. However, software license fees are treated differently from purchased software costs for tax purposes. Payments for leased or licensed software used for your website are currently deductible as ordinary and necessary business expenses.
Was the software developed internally?
If, instead of being purchased, the website is designed in-house by the taxpayer launching it (or designed by a contractor who isn’t at risk if the software doesn’t perform), bonus depreciation applies to the extent described above. If bonus depreciation doesn’t apply, the taxpayer can either:
- Deduct the development costs in the year paid or incurred, or
- Choose one of several alternative amortization periods over which to deduct the costs.
Generally, the only allowable treatment will be to amortize the costs over the five-year period beginning with the midpoint of the tax year in which the expenditures are paid or incurred.
If your website is primarily for advertising, you can currently deduct internal website software development costs as ordinary and necessary business expenses.
What if you pay a third party?
Some companies hire third parties to set up and run their websites. In general, payments to third parties are currently deductible as ordinary and necessary business expenses.
What about expenses before business begins?
Start-up expenses can include website development costs. Up to $5,000 of otherwise deductible expenses that are incurred before your business commences can generally be deducted in the year business commences. However, if your start-up expenses exceed $50,000, the $5,000 current deduction limit starts to be chipped away. Above this amount, you must capitalize some, or all, of your start-up expenses and amortize them over 60 months, starting with the month that business commences.
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We can determine the appropriate tax treatment of website costs. Contact us if you want more information.
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