Nowadays, almost every business has a website. However, the IRS has yet to issue formal guidance on when website costs can be deducted.
Fortunately, established rules that generally apply to the deductibility of business costs provide some guidance on how to properly treat the costs related to launching a website. In addition, businesses can refer to IRS guidance on software costs.
Hardware or software?
Let’s start with the hardware required to run a website. The expenses are covered by the standard rules for depreciable equipment. Specifically, once these assets are operational, you can deduct 100% of the cost in the first year (before 2023). This preferential treatment is permitted by the 100% first-year bonus depreciation break. It should be noted that the bonus depreciation rate will begin to decline for property placed in service after calendar year 2022.
Later on, you will most likely be able to deduct 100% of these costs in the year the assets are placed in service, thanks to the Section 179 first-year depreciation deduction privilege. However, Sec. 179 deductions are subject to a number of restrictions.
The maximum Sec. 179 deduction is $1.08 million for tax years beginning in 2022, subject to a phaseout rule. The deduction is phased out if more than a certain amount of qualified property ($2.7 million in 2022) is placed in service during the year, according to the rule.
In addition, there is a taxable income limit. It states that your Sec. 179 deduction cannot exceed your taxable business income. In other words, Section 179 deductions cannot generate or increase a net tax loss. Any Sec. 179 deduction amount that you are unable to deduct immediately is carried forward and can be deducted in future years (to the extent permitted by the applicable limits).
Similar rules apply to commercially available software. However, for tax purposes, software license fees are treated differently than purchased software costs. Currently, website costs for leased or licensed software used for your website are deductible as ordinary and necessary business expenses.
Was the software developed internally?
If the website is designed in-house (or by a contractor who is not at risk if the software fails) instead of being purchased, bonus depreciation applies to the website costs to the extent described above for tax years beginning before calendar year 2022. If bonus depreciation does not apply, the taxpayer has two options:
1. Deduct development costs in the year they were paid or incurred, or
2. Select one of several amortization periods from which to deduct the costs.
Generally, the only allowable treatment for tax years beginning after calendar year 2021 will be to amortize the costs over a five-year period beginning with the midpoint of the tax year in which the expenditures are paid or incurred.
Internal website software development costs can currently be deducted as ordinary and necessary business expenses if your website is primarily for advertising.
Are you paying a third party?
Some businesses hire third parties to set up and maintain their websites. Website costs paid to third parties are currently deductible as ordinary and necessary business expenses in general.
What about before business begins?
Website costs can be included in startup costs. Generally, you can deduct up to $5,000 in otherwise deductible expenses incurred prior to the start of your business in the year it starts. However, if your startup costs exceed $50,000, the $5,000 current deduction limit begins to dwindle. Above this amount, you must capitalize some or all of your start-up costs and amortize them over 60 months, beginning with the month in which your business begins.
Our advisors can help determine the appropriate treatment of website costs for federal income tax purposes. Contact us if you have questions or want more information.
This post was originally published in September of 2020. Post updated August 2022.