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You’re
not on the Net? You’ve been eschewing the Web? Developing
a site on the Internet is something every professional DJ
should be doing. Few DJs, however, have given much thought
to the helping hand provided by Uncle Sam when it comes
to tax breaks. Naturally, your company’s IRS bill can be
greatly diminished by such tax breaks, but did you know
that these breaks will also sharply reduce the out-of-pocket
cost for developing and operating your Web site?
Not
too surprisingly, given the complexity of our tax rules,
designing and maintaining a Web site involves a variety
of costs that should be identified and accounted for separately.
Some costs are deductible immediately as expenses, while
others are so-called "capital expenses" that can
only be deducted over a period of time and some of those
costs may even produce tax credits—directly reducing your
company’s tax bill.
Can
You Spell Loophole?
Since
the Miracle New York Mets of 1969, neither our lawmakers
nor the Internal Revenue Service have addressed the question
of tax deductions for software. In other words, there exist
no regulations that spell out how Web development costs
should be treated. That, of course, leaves many unanswered
questions. There are, however, several precedents that can
produce a number of legitimate tax deductions for your company.
Can you spell loophole?
Does
your company’s foray onto the Internet constitute a new
business? This is one example of an "unanswered"
question that has yet to be dealt with by the IRS. But take
the example of a furniture distributor who opens a retail
outlet to sell his goods. According to the IRS, he has opened
a new business. And new business startup costs can be capitalized
and written off over a period of years.
Or
how about the money doled out by a furrier who opens an
additional retail outlet? Or a machine-parts distributor
opening another warehouse? These, considered routine "ordinary
and necessary" business expenses, are tax deductible
on an annual tax return as "expenses."
Obviously,
immediately deductible expenses reduce out-of-pocket costs
far more than does a deduction for depreciation—such as
equipment that must be taken over a number of years. Although
the IRS has not yet outlined a specific tax treatment for
Web development costs, clues do exist elsewhere in the tax
code.
Those
areas where the IRS—or our lawmakers—have provided examples
of the proper tax treatment of Web development "related"
costs can produce substantial tax savings for your DJ business.
Software, for example, is considered an "intangible
asset" to your DJ business. But there are two types
of software that is used to create a Web site: purchased
or customized.
The
tax rules for purchased software are pretty straightforward:
it cannot be characterized as an intangible asset, and is
usually depreciated using the straight-line method over
three years, beginning in the month that it is placed in
service.
Self-created,
or customized, software deductions are more questionable.
Today, the expense of developing your own software (whether
for your own use or for sale to others) may either be deducted
currently or amortized over a five-year period—so long as
such costs are treated consistently.
But
is a Web-related expenditure really for software? After
all, how can any DJ differentiate between whether a cost
is for software, whether it relates to graphics or to content?
The answer: Each receives its own, unique tax treatment.
Consider
a DJ company, say, called, A Different Beat. They create
a Web site primarily for advertising purposes, to generate
leads, although they do have the facility to make sales
and even book events on-line. They display dozens of digital
photos, some of which are "virtual reality" shots
that allow viewers to more fully experience the sights,
the sounds and the audience’s enthusiasm for their DJs.
Thousands of dollars go into these photos. In addition,
A Different Beat pays a designer thousands of dollars to
create the "look and feel" of the Web site, including
the page layouts and navigational buttons. This personnel
is, of course, deductible.
The
cost of page layouts and navigational buttons will probably
be included as part of the software cost; photo costs will
not. Why? Graphics that are integral to a Web page, such
as basic design elements and navigational buttons, are generally
understood to be part of the software that creates a Web
site. However, graphics that comprise the content of a Web
site are not. Remember, the basic rules in this area were
created in 1969, and therefore these regulations are blind
to non-software elements included in today’s software applications
such as graphics, sound, video and content.
Web
Deductions
Certain
graphics, such as layout and logo design, are primarily
advertising and are deductible as such. However, for a number
of Web sites—most notably adult Web sites—graphics generate
fees. It is questionable whether the costs related to these
latter graphics are tax deductible and, if they are, over
what period. Are those digital photos considered "artwork,"
which is generally not tax deductible?
Content
vs. Advertising
It
seems strange that content, unlike software and graphics,
is not considered an integral part of a Web site’s development.
Content is best defined as the information that is delivered
by a Web site, the material that can be easily changed without
affecting the site’s basic architecture. For example, a
bride will go to your site seeking advice on song lists
and first dances—in other words, she seeks your professional
"advice."
Obviously,
it costs money for you to develop this content. Can it be
written off? If you are an employee of your own corporation,
for example, the wages your corporation pays you can be
allocated to Web content, thus creating a write-off of either
immediate or capitalized expenses. Of course, if you want
to pay someone else to develop your content, then that is
deductible.
And
once again, the tax rules relating to the deduction of such
costs is unclear. On one hand, some authorities back the
assumption that literary content developed for a Web site
can be deducted. On the other hand, a 1992 decision by the
U.S. Supreme Court (INDOPCO) provided a general rule that
costs resulting in benefits extending beyond the current
year should be capitalized.
Many
Web sites are primarily devoted to advertising. Advertising
is generally tax deductible as incurred—even when it may
result in a long-term benefit to the DJ.
Domain
Names
What
is a Web site without a domain name? Today, more and more
DJs must pay to acquire an already registered domain name.
The rising prices at which domain names change hands beg
for a tax deduction. Again, the issue is not a cut-and-dried
one, but Section 197—which deals with the acquisition of
an intangible asset – may apply, resulting in a 15-year
life for purchased domain names. Or, a domain name might
be judged by some to be an intangible asset to which Section
197 does not apply and which has no ascertainable life.
In this case, no deduction would be available for the cost
of a domain name until it is sold or abandoned.
The
fact that neither our lawmakers nor the IRS has addressed
the tax treatment of Web site development costs works both
ways for any DJ who itemizes, documents and tracks his costs.
Any taxpayer who can justify their treatment of expenses
and who treats those expenses in a consistent manner from
year-to-year will normally do so without question. The IRS
may even permit some or all Web site development costs to
be considered for the ultimate: a tax credit for research
and experimentation.
Research
and Experimentation
In
Mary Shelley’s famous book, Frankenstein, the good
doctor’s experiments on his monster would have earned him
a tax credit for research and experimentation. Our tax rules
still register a credit for amounts spent on research and
experimentation. Extremely regulated and very narrow in
scope, the R&E tax credit is available, in some instances,
for so-called "internal-use software."
Internal-use
software, obviously, is software that’s used primarily for
internal purposes, such as bookkeeping, inventory management
or order processing.
Some
Web site software—such as an on-line tax preparation program
or an on-line game, both of which are intended primarily
for customer use—is clearly not internal-use software. Other
Web site applications, such as an application devoted to
network management or pure order processing software, are
likely to be considered to be for internal use.
The
IRS recently proposed regulations that would, in the view
of many experts, thwart Congressional intent and make it
impossible for anyone to claim the tax credit for R&E.
Some say that IRS field agents are already taking the position
that nothing qualifies for the credit.
Fortunately,
aside from the controversial tax credit, most of the costs
of developing and maintaining a Web site for your DJ business
are tax deductible. The argument that you should itemize
these costs in order to qualify for these tax deductions
is bolstered by the lack of specific IRS rules over what
is deductible, what is depreciable and what is not deductible
at all.
If
you have any questions for Mark Battersby, please write
to DJ Times c/o TCB, 25 Willowdale Ave., Port Washington,
N.Y., 11050, fax 516-944-8372 or e-mail djtimes@testa.com.
If
you have any questions for TCB, please write to
DJ
Times c/o TCB,
25 Willowdale Ave.
Port Washington, N.Y., 11050
fax 516-944-8372
e-mail djtimes@testa.com.
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