As the end of the taxable year approaches, the decision to purchase software is important for the business owner. Eric R. Shivers, CPA offers some insight into tax planning for some beneficial deductions of year end purchases.
Details of the Deduction
The IRS allows for the benefit of a current year deduction for purchased computer software through a special election on the taxpayer’s federal income tax return. Generally, software that is purchased is amortized (expensed) over 36 months. The special election under Code Sec. 179, allows the tax payer to deduct 100% of the purchased software costs in the year of purchase, up to taxable net income.
For example, if a purchase of software is $5,000, then as long as the taxpayer’s taxable net income is above the $5,000, then all of that purchase is deductible.
The Congress understands the importance of investing in your business. This election is meant to help you in that regard. By making this election, you can reduce your taxable income, and thus your taxes, with this purchase.
Other issues related to software purchase depend upon the time and use of the software. Generally, if the software’s ‘useful’ life is less than one year, then that purchase is deductible as a business expense. Another situation is a leasing or subscription arrangement: with the further use of ‘cloud’ software and other internet based programs, you may not have ownership of the software you are using. In most circumstances, that lease or subscription payment is an ordinary business expense and is deductible.
The costs of developing software can be added to the basis (or cost) of the software that was purchased, further adding to the ability to make the Sec. 179 election. There are additional rules and parameters in this area, depending upon your circumstances.
Implementation and training costs for new software are always a part of any software change. The IRS allows for these costs to be deducted as ordinary trade or business expenses. Other nuances in this area related to whether it’s an ‘implementation’ or a ‘development’ should be looked at on a case-by-case basis with your tax advisor.
For costs related to integrating the software with web based functions (or even website development), the IRS has not issued any official guidance on this matter. Typically, in practice, the costs associated with website development have been treated both as an asset (which is amortized and eligible for the Sec. 179 election) and expensed. Judgment and guidance from your tax advisor is helpful in this situation.
Depending upon the state where you are taxed, several states have ‘decoupled’ from the federal Sec. 179 elections in some way. The downturn in the economy has hit several states in their budgets. The de-coupling (or disallowing of either some or all of the Sec. 179 deduction) has been a means for states to prop up their income. If you are subject to your particular states treatment of the federal Sec. 179 election, you will need to plan for the effect of that treatment.
Among other tax planning matters business owners face, the ability to make the Sec. 179 election on these kinds of purchases is an advantage many owners take for reducing their taxes. Since Sec. 179 is always adjusted for taxable income levels, it is anticipated that Congress will continue to use this election as a means to help further stimulate economic activity.
Eric is a CPA and Manager at James N. Rudolph, P.A. in Oviedo, FL. You may email him at firstname.lastname@example.org
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