business expenses

Business Website Expenses: Managing Them for Tax Benefits

Ken Botwinick, CPA | 08/01/2024

Understanding Tax Treatment for Business Website Expenses

With most businesses now having websites, it’s important to know how these costs can be handled for tax purposes, even though the IRS hasn’t provided specific guidance on this topic.

However, there are general rules for business expense deductions that can offer some clarity, as well as guidance on software costs from the IRS. Here’s a breakdown of how website-related expenses might be treated for tax purposes:

Tax Treatment of Hardware vs. Software

Hardware Costs: The hardware required for a website, such as servers and computers, is generally considered depreciable equipment. For 2024, you can deduct 60% of the cost in the first year it is placed in service under the bonus depreciation provision. This rate has decreased from 100% in 2022 to 60% in 2024, and it will continue to decline until it phases out in 2027 unless Congress extends or modifies it.

Alternatively, you might be able to fully or partially deduct these costs in the year they are placed in service using the Section 179 deduction. For 2024, the maximum Section 179 deduction is $1.22 million, but it phases out if the total amount of qualifying property exceeds $3.05 million. Additionally, the deduction cannot exceed your business taxable income, though any unused amount can be carried forward to future years.

Software Costs: For off-the-shelf software, tax treatment is generally similar to hardware. Payments for leased or licensed software used on your website are deductible as ordinary and necessary business expenses. However, costs associated with purchased software are treated differently.

Internally Developed Software: If your website is developed in-house or by a contractor, you can apply bonus depreciation to the extent allowed. If bonus depreciation does not apply, you can either:

Deduct the development costs in the year they are incurred, or
Amortize the costs over five years starting from the midpoint of the tax year in which the expenses were incurred.

For websites primarily used for advertising, internal development costs can be deducted as ordinary business expenses.

Third-Party Costs: Payments to third parties for setting up or managing your website are generally deductible as ordinary business expenses.

Start-Up Expenses: Website development costs incurred before your business starts can be considered start-up expenses. You can deduct up to $5,000 in these costs in the year your business begins. If start-up expenses exceed $50,000, the $5,000 deduction limit is reduced dollar-for-dollar for every dollar over this threshold. The remaining costs must be capitalized and amortized over 60 months, starting from the business commencement month.

Need Assistance?

Determining the correct tax treatment for your website expenses can be complex. Contact Botwinick & Company for help in navigating these rules and ensuring proper tax treatment for your business’s website costs.

Tax Treatment of Partner-Incurred Expenses in Service Partnerships

Ken Botwinick, CPA | 05/03/2024

It is not uncommon for partners in service partnerships, such as architecture or law firms, to incur expenses related to the partnership’s business. For example, partners may incur entertainment expenses when developing new client relationships or expenses for transportation to and from client meetings, professional publications, continuing education, and home office expenses. What is the tax treatment of such expenses? Here are the answers.

Reimbursable Expenses

As long as the expenses are those that a partner is expected to pay without reimbursement under the partnership agreement or firm policy (written or unwritten), the partner can deduct these expenses on Schedule E of Form 1040. Conversely, a partner cannot deduct expenses if the partnership would have honored a request for reimbursement.

A partner’s unreimbursed partnership business expenses should also generally be included as deductions in arriving at the partner’s net income from self-employment on Schedule SE.

For instance, suppose you are a partner in a local architecture firm. According to the firm’s partnership agreement, partners are expected to bear the costs of soliciting potential new business except in cases where attracting a large potential new client is a firm-wide goal. If you spend $4,500 of your own money on meal expenses to attract new clients and receive no reimbursement, you should report a deductible item of $2,250 (50% of $4,500) on your Schedule E. This $2,250 should also be included as a deduction in calculating your net self-employment income on Schedule SE.

However, it is crucial to note that a partner cannot deduct expenses if they could have been reimbursed by the firm. No deduction is allowed for “voluntary” out-of-pocket expenses. To avoid any confusion regarding the tax treatment of unreimbursed partnership expenses, it is advisable to establish a written firm policy clearly stating what will and will not be reimbursed. This ensures that partners can deduct their unreimbursed business expenses without issues from the IRS.

Home Office Deduction

Subject to the normal deduction limits under the home office rules, a partner can deduct expenses allocable to the regular and exclusive use of a home office for partnership business. The partner’s deductible home office expenses should be reported on Schedule E in the same manner as other unreimbursed partnership expenses.

If a partner has a deductible home office, the Schedule E home office deduction can provide multiple tax-saving benefits because it is effectively deducted for both federal income tax and self-employment tax purposes.

Additionally, if the partner’s home office qualifies as a principal place of business, commuting mileage from the home office to partnership business temporary work locations (such as client sites) and partnership permanent work locations (such as the partnership’s official office) counts as business mileage.

The principal place of business test can be satisfied in two ways:

The partner conducts most of the partnership’s income-earning activities in the home office.
The partner conducts partnership administrative and management tasks in the home office and does not make substantial use of any other fixed location (such as the partnership’s official office) for these tasks.

Conclusion

When a partner can be reimbursed for business expenses under a partnership agreement or standard operating procedures, they should submit these expenses for reimbursement. Otherwise, the partner cannot deduct the expenses. The partnership should establish a written policy clearly stating what expenses will and will not be reimbursed, including home office expenses if applicable. This applies equally to members of LLCs treated as partnerships for federal tax purposes since those members are considered partners under tax law.

For assistance with these issues or any other concerns related to your partnership, please contact us.

What Types Of Expenses Can’t Be Written Off By Your Business?

Ken Botwinick, CPA | 10/09/2023

If you read the Internal Revenue Code (and you probably don’t want to!), you may be surprised to find that most business deductions aren’t specifically listed. For example, the tax law doesn’t explicitly state that you can deduct office supplies and certain other expenses. Some expenses are detailed in the tax code, but the general rule is contained in the first sentence of Section 162, which states you can write off “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Basic definitions

In general, an expense is ordinary if it’s considered common or customary in the particular trade or business. For example, insurance premiums to protect a store would be an ordinary business expense in the retail industry.

A necessary expense is defined as one that’s helpful or appropriate. For example, let’s say a car dealership purchases an automated external defibrillator. It may not be necessary for the operation of the business, but it might be helpful and appropriate if an employee or customer suffers cardiac arrest.

It’s possible for an ordinary expense to be unnecessary — but, in order to be deductible, an expense must be ordinary and necessary.

In addition, a deductible amount must be reasonable in relation to the benefit expected. For example, if you’re attempting to land a $3,000 deal, a $65 lunch with a potential client should be OK with the IRS. (Keep in mind that the Tax Cuts and Jobs Act eliminated most deductions for entertainment expenses but retained the 50% deduction for business meals.)

Examples of taxpayers who lost deductions in court

Not surprisingly, the IRS and courts don’t always agree with taxpayers about what qualifies as ordinary and necessary expenditures. Here are three 2023 cases to illustrate some of the issues:

A married couple owned an engineering firm. For two tax years, they claimed depreciation of $76,264 on three vehicles, but didn’t provide required details including each vehicle’s ownership, cost and useful life. They claimed $34,197 in mileage deductions and provided receipts and mileage logs, but the U.S. Tax Court found they didn’t show any related business purposes. The court also found the mileage claimed included commuting costs, which can’t be written off. The court disallowed these deductions and assessed taxes and penalties. (TC Memo 2023-39)
The Tax Court ruled that a married couple wasn’t entitled to business tax deductions because the husband’s consulting company failed to show that it was engaged in a trade or business. In fact, invoices produced by the consulting company predated its incorporation. And the court ruled that even if the expenses were legitimate, they weren’t properly substantiated. (TC Memo 2023-80)
A physician specializing in gene therapy had multiple legal issues and deducted legal expenses of $360,295 for two years on joint Schedule C business tax returns. The Tax Court found that most of the legal fees were to defend the husband against personal conduct issues. The court denied the deduction for personal legal expenses but allowed a deduction for $13,000 for business-related legal expenses. (TC Memo 2023-42)

Proceed with caution

The deductibility of some expenses is clear. But for other expenses, it can get more complicated. Generally, if an expense seems like it’s not normal in your industry — or if it could be considered fun, personal or extravagant in nature — you should proceed with caution. And keep careful records to substantiate the expenses you’re deducting. Consult with us for guidance.

Q&A

How do you know if a business expense is considered “ordinary”?

An expense is considered “ordinary” if it is common and accepted in the industry or trade in which the business operates. This means that the expense must be typical and customary for businesses in that particular industry. It should not be excessive or unusual compared to what other businesses in the same industry would typically incur. Determining if an expense is ordinary often requires professional judgment and knowledge of industry standards and practices. In general, expenses that are necessary for the day-to-day operations of a business and directly related to generating revenue are more likely to be considered ordinary. It is important to consult with a professional accountant or tax advisor for specific guidance on classifying expenses as ordinary for your particular business.

How do you know if a business expense is considered “necessary”?

A necessary expense is one that is helpful and appropriate for your business. To determine if a particular expense is necessary, you should consider whether it directly relates to your business operations, contributes to the generation of income, or helps you maintain or improve your business’s efficiency and productivity. It’s important to note that in order for an expense to be deductible, it must be both ordinary and necessary.

When determining whether to deduct an expense for your business, are there any other factors to consider in addition to whether the expense is ordinary and necessary?

When determining whether to deduct an expense for your business, there are a few other factors to consider in addition to whether the expense is ordinary and necessary. These factors include substantiation (having proper documentation to support the business purpose of the expense), reasonableness (in relation to the nature of your business and industry standards, treating excessively lavish expenses with caution and additional consideration), a direct connection to your business activities and income/operations, proportional use (only deducting the portion that is used for business purposes if the expense has both business and personal use), and compliance with tax laws (ensuring that the expense meets all applicable tax laws and regulations, including any specific rules or limitations related to certain types of expenses).