Maximizing tax deductions for your practice's web site
Source: Urology Times
Publication date: 2001-01-01

Today, many professionals are developing a presence on the Internet. Few urologists, however, seem to have given any thought to the financial helping hand that is provided by the Internal Revenue Service in the form of tax breaks. Tax deductions can reduce your urology practice's tax bill and sharply reduce the out-of-pocket costs for developing and operating a web site.

Not too surprisingly, given the complexity of our tax rules, developing 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, and some are so-called "capital expenses" that can only be deducted over a period of time. Some of those costs may even produce tax credits, directly reducing the practice's tax bill.

Is a web site deductible?

Neither our lawmakers nor the IRS have seen fit to address the question of tax deductions for computer software since 1969. In other words, no regulations currently spell out how web development costs should be treated. However, while there are a lot of questions, there are also a number of precedents that can produce a number of legitimate tax deductions.

Among the questions that can't be answered is whether your urology practice's foray onto the Internet constitutes a new "business." The expenses of a urologist opening another office or even a group practice opening another clinic are, in most cases, considered routine, "ordinary and necessary" business expenses and are tax deductible on the practice's annual tax return as "expenses." A distributor who opens an on-line retail outlet for the same type of goods that it has distributed for years, for example, is considered to have opened a new business.

Although the IRS has not yet outlined the specific tax treatment for any web development costs, clues exist elsewhere. The proper tax treatment of web development costs can produce substantial tax savings for your practice.

Deductions for 'intangible assets'

Software that is used to create a web site, whether purchased or self-created, is considered to be an "intangible asset" of the urology practice. Although the tax rules for purchased software are pretty straightforward, self-created software deductions are more questionable.

Today, the expense of developing software (whether for a practice's own use or for sale to others) may either be currently deducted or amortized over a 5-year period, just as long as such costs are treated consistently. Purchased software, which cannot be characterized as an intangible asset acquired as part of a business acquisition, is usually depreciated using the straight-line method over 3 years beginning in the month that it is placed in service.

But is a web-related expenditure just for software? How can you differentiate between whether a web site's cost is for software, graphics, or content? Each facet of your developing web site receives its own, unique tax treatment.

Consider a hypothetical urology practice that creates a web site primarily for public relations purposes but also to accept referrals and answer on-line questions. The practice's web site uses dozens of photos, some of which are "virtual reality" shots. Thousands of dollars went into these photos. In addition, the practice pays a designer thousands of dollars to design the look and feel of the web site, including the page layouts and navigational buttons.

The cost of page layouts and navigational buttons will probably be part of the software cost while the photo costs will not. As mentioned, the basic rules in this area were created in 1969 and have not been updated since. Those regulations take no account of non-software elements included in today's software applications such as graphics, sound, video, and content.

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. Graphics that are part of the content of a web site are not part of the software. Some graphics are considered advertising and are deductible as such. However, for a number of 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 digitized photos considered "artwork" which is generally not tax deductible?

Strangely, content is not considered to be an integral part of the development of a web site in the same way software and graphics are. Content is best defined as what is delivered by a web site. Software might be viewed as the foundation of the site, whereas the content is the material that can be readily changed without affecting the web site's basic architecture.

The content of any web site includes informational content that is clearly not advertising since what attracts "surfers" to many sites is unbiased advice. Obviously, considerable costs are incurred to develop this content. Once again, however, the tax rules related to the deduction of such costs are not clear.

On one hand, there are a number of authorities backing 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, Inc. vs. Commissioner, 503 U.S. 79 [1992]) provided a general rule that costs resulting in benefits extending beyond the current year should be capitalized.

What's in a (domain) name?

Today, more and more professionals must pay to acquire an already registered domain name. The rising prices at which domain names change hands begs for a tax deduction. Again, the issue is not cut-and-dried.

Section 197 dealing 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 was 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 urologist who breaks down, documents, and tracks the incurred costs. Any professional who can justify the treatment of expenses and who treats those expenses in a consistent manner 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. Extremely regulated and very narrow in scope, this tax credit is available, in some instances, for so-called "internal use software," defined as software used primarily for internal purposes, such as bookkeeping, inventory management, or order processing.

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 research and experimentation. 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 urology practice are deductible. The argument for breaking down those costs to qualify for those tax deductions that will do your practice the most good is bolstered by the lack of specific rules. Here, the lack of tax regulations can work in your favor.

UT

Mark E. Battersby UT CONTRIBUTING COLUMNIST
Mark E. Battersby is a financial and tax consultant based in Ardmore, PA.

Copyright Advanstar Communications, Inc. Jan 2001

Publication date: 2001-01-01
© 2000, YellowBrix, Inc.

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