IRS affirms deductibility of some - but not all - computer software development and implementation costs.

• Author: Chou, Yuan

In December 2015, the IRS released Chief Counsel Advice (CCA) 201549024, relating to the federal income tax treatment of software development costs. Although this type of authority may not be used or cited as precedent, the CCA provides helpful insight into the IRS's approach when examining the deductibility or capitalization of software-related costs. The issuance of the CCA affirms that not all computer software development and implementation costs are deductible when paid or incurred and that certain software-related costs must be capitalized and recovered through amortization for federal income tax purposes.

Relevant Authorities

Most guidance for dealing with software development costs can be found in two IRS pronouncements from the early 2000s. In Rev. Proc. 2000-50, the IRS provided guidelines on the treatment of the costs of computer software and in Section 2 defined the term "computer software" as any program or routine (i.e., any sequence of machine readable code) that is designed to cause a computer to perform a desired function or set of functions, and the documentation required to describe and maintain that program or routine. Rev. Proc. 2000-50 is particularly well-known for the following language:

The costs of developing computer software (whether or not the particular software is patented or copyrighted) in many respects so closely resemble the kind of research and experimental expenditures that fall within the purview of [Sec. 174] as to warrant similar accounting treatment. Thus, because software development costs are similar to, but may not necessarily constitute, research and experimentation expenditures under Sec. 174, the IRS prescribes three methods of accounting for treating computer software development costs. According to Rev. Proc. 2000-50, the IRS will not disturb a taxpayers treatment of costs paid or incurred in developing software for any particular project, either for the taxpayer's own use or to be held by the taxpayer for sale or lease to others, where:

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1. All of the costs properly attributable to the taxpayer's development of software are consistently treated as current expenses and deducted in full in accordance with rules similar to those applicable under Sec. 174(a); or

2. All of the costs properly attributable to the taxpayer's development of software are consistently treated as capital expenditures that are recoverable through deductions for ratable amortization in accordance with...