Tax rules generally take a while to be updated to apply to new modes and ways of doing business. Internet website development has been one of those areas where the tax code continues to play catch-up. For the business owner or manager in charge of accounting for related taxes on such activities, the rules can be a bit confusing.
The validity of a domain name cost as a viable tax deductible expense depends on how the expense occurs. To begin with, the cost needs to be specifically identified. Domain name costs can arrive in a variety of ways. These include domain registration, purchase of an existing domain, development and brand design including the creation of a domain name, and revision work. The applicable tax rules vary depending on which category an expense falls into.
The first step for a taxpayer to confirm is which type of tax treatment applies. The taxpayer needs to determine if related expenses associate with a hobby or with a business.
Tax Treatment as a Hobby
Hobbies have a special treatment from the U.S. Internal Revenue Service since the agency understands that some hobbies can be profitable but are not full-fledged businesses. A tax filer notifies the IRS of a hobby’s existence when filing personal income taxes. The tax rules generally allow expenses to maintain the hobby to be deducted from the hobby’s declared income. However, such expenses, whether they are Internet-related or any other kind of expense, are not allowed to be more than the profit declared. In other words, the tax filer must avoid declaring hobby income as a loss. The lowest the hobby income can be is net zero as a dollar amount for the tax year. So domain name costs can be included if domain name collecting is the tax filer’s hobby, but the expense cannot exceed the total income earned from the activity.
Tax Treatment as a Business
The IRS looks at domain name costs in two ways: capital costs and ongoing, recurring business expenses. General registration, added domain name protection services and recurring maintenance costs for a domain name are all considered regular business expenses. These are deductible from income a business may earn in the same tax year.
However, where a business purchases a domain name that already exists, or invests heavily to develop that domain name as a brand and trademark, then the IRS looks at the related expense as a permanent business benefit. Such expenses move toward capital costs that need to be depreciated over time, much the same way as a company vehicle purchase is reported and depreciated. Doing so reduces the deduction benefit of the domain name expense against a single year’s income.
For either a business or hobby involving a domain name cost, documentation represents the best success for defending one’s case before the IRS. Receipts, invoices, emails involving payments, and bank statements provide valid, legal proof of expenses with sufficient detail to identify the cost and who charged it. Hearsay and verbal recollection generally fails any practical level of proof for tax agencies
Responding to an Audit
If you find yourself being audited for including a domain name cost as a business or hobby expense in your taxes, avoid panicking. IRS reviews, known as audits, occur regularly. Audits can be triggered by automated screening, red flag areas of tax filing, random selection or external information provided to the IRS. Rely on your documentation and explain your actions fully. Then work with the auditor to close the issue in a timely manner. Do not delay responding or ignore the audit; this can result in serious penalties.
- All Business: Seeking Guidance – Treatment of Web Development Costs
- Tax-News.com: Professor Hardesty’s Analysis of the U.S. Tax Treatment of Domain Name Value
- Domain Name Journal: Tips on Proper Reporting of Your Domain Name Sales on U.S. Personal Tax Returns
- Mondaq: U.S. – Tax Implications of Incurring Website Development Costs
- U.S. Internal Revenue Service: Publication 556
Since 2009 Tom Lutzenberger has written for various websites, covering topics ranging from finance to automotive history. Lutzenberger works in public finance and policy and consults on a variety of analytical services. His education includes a Bachelor of Arts in English and political science from Saint Mary's College and a Master of Business Administration in finance and marketing from California State University, Sacramento.