Any small business owner knows that tax forms and guidelines are complex. As impossible as it may seem, tax filers need to navigate this field successfully to make the most of a business.
This is becoming increasingly complicated as tax laws constantly lag behind changes in the business field due to technology. Technology is constantly changing and the role that it plays in business is always evolving and the huge tax engine has never been able to keep up.
One of these topics is Capital Expense. Here, we’ll talk about what capital expense means, how you might be able to count website development cost as a capital expense, and what that can mean for filing and returns.
We get asked about the tax implications of web or mobile development all the time by the clients. We are experts in app development, not so in tax laws. But here is what we learned from many clients and their accountants.
A Brief Introduction to Expenses on Taxes
Business costs can be divided into two main categories, Capital Expense, and Operating Expense.
Most expenses that you might think of when it comes to a business like a payroll, buildings, equipment, &c. fit rather neatly into either capital expenses or operating expenses but this isn’t always the case.
This is especially true when it comes to expenses relating to technology including website development and app development.
There are also other cost categories that have less to do with what the expense looked like on your end and more to do with how the cost was intended to impact your business.
Examples include Marketing and Advertising Expenses. Marketing and Advertising Expenses is a more complicated and narrowly defined field that often includes website development and app development costs.
However, claiming your website development and app development costs as marketing and advertising expenses rather than as capital expenses or operational expenses can affect your tax returns and status differently than capital expenses and operational expenses.
In some cases, these web development and app development can be legally categorized as any of these kinds of expenses. It might sound like that makes things easier but how a business chooses to categorize these more ambiguous expenses is anything but arbitrary.
Randomly picking one field might cover your legal obligations but putting in some more time and making a more careful decision can help to get you more money back on your taxes, change the way your business appears to partners and investors, and more.
What Are Capital Expenses?
Capital expense accounts for large purchases that will be used into future tax seasons. This usually means equipment purchases like buildings & hardware.
Capital investments are recorded on tax forms and taxed as assets and investment activities. That’s because the capital is now owned by your company (making it an asset) and because you are hoping that the purchase will at least pay for itself by saving you money or making you more money (making it an investment).
Recording capital expenses can make your business seem more profitable by recording costs paid as investment and assets that your business owns rather than as costs that your business has paid.
It’s easy to see how a website fits these requirements but assets are usually subject to depreciation- having a value that falls value over time. This isn’t necessarily true of websites although the argument can be made, especially if you plan on having a website made but not carefully curated.
Further, while investment can go up in value making the owner more valuable, it isn’t usual for the value of a website to go up independently from the value of the business that owns it.
Similarly, owning assets contributes to the value of a business because if a delivery business goes under it can sell the vehicles or if the business is bought out then owning the vehicles makes the business more valuable. If most businesses go under, they don’t sell their websites.
However, some businesses are able to sell their websites – especially if the website is intimately related to what the business does. Similarly, if you do have a really well-made website that does play a significant role in your business it could well be the case that the website makes the business more valuable just like material resources would.
What Are Operational Expenses?
Operating expenses are smaller, day-to-day expenses that benefit the business for a shorter amount of time, like payroll, utilities, and other short-term expenses.
As mentioned above, most of the cost of software development comes from paying software developers, which sounds a lot like an operating expense. Too many tax experts, paying a designer to make your website doesn’t look that different from paying a secretary to check your email.
Operating expenses are tax-deductible, in part because the government wants to encourage these expenses, which are good for the economy because they encourage things like employment.
However, recording a lot of operating expenses can also make your business appear less profitable. While practically speaking paying for the production of an online asset or paying for an online service aren’t that different, on paper owning an online asset looks very different from paying for an online service.
What expense is Website and App Development?
The IRS has no specific guidelines classifying website and app development. So, where does website development land? Most of the expenses of website development are paying for an individual or team to develop the website and that sounds a lot like an operating expense.
However, what you’re paying for them to develop is an online platform that your business will use for years to come and that sounds a lot like capital.
So, is website development a capital expense or an operating expense? In some ways, this is an almost philosophical question that has to do with whether websites are services (like driving a delivery vehicle- an operational expense) or infrastructure (like the delivery vehicle itself- a capital expense).
This has to do with how you pay for your website and what it does for your company. To some extent, the business owner also has some freedom to classify costs as they wish. There are also a few more tax fields besides capital and operational expenses that can come into play.
Other Considerations and Tax Classifications
If you have in-house web developers or freelancers, paying for your website development is classed as an operational expense because the government sees it as you paying employees for service.
Once again, operational expenses are not necessarily good or bad because they are tax-deductible (meaning a bigger refund) but they also make your business look like it has expenses rather than investments and assets.
If you work with a third-party group to develop your website or app you can categorize it as a capital expense because the government sees it as you buying a product from a provider rather than you paying employees for service.
Again, capital expenses are neither good nor bad. They are not tax-deductible (meaning a smaller refund) but they categorize costs as assets and investments making your business look more valuable on paper.
Web Marketing and Advertising- Operational or Capital Expenses?
Depending on how you pay for your website development or app development, it may qualify as either operational expenses or capital expenses. But what about website costs other than development, like web hosting and maintenance?
Depending on how you use your website, these expenses may qualify as marketing costs. Marketing costs are not deductible in the same way that operational expenses are but they do often qualify for various tax breaks.
However, the guidelines for what qualifies a marketing expense are more strictly defined. They have to directly contribute to the revenue that your business makes through sales and services.
If you already have a website, its maintenance and associated costs may qualify as advertising costs.
However, for some businesses and depending on how the website will be used to advance your business, all associated costs of website development and other software development outsourcing may be able to fall under marketing expenses – avoiding the capital expense vs. operational expense altogether.
Is Web Development a capital expense? – The Takeaway
This company is not a tax-filing company, finance company, or legal advice company. This article was carefully researched but was not written by a tax expert.
As a result, the content in this article is meant to inform you as you move forward but if you are unclear about how to classify your website or app development costs please consult a tax preparation expert before you file.
As you’ve probably gathered while reading this article, classifying app development and website development expenses is not a simple issue. It depends on who is developing your website or app, how you are paying for it, how you are going to use your website or app and the role of your business overall.
Further, How you classify these costs can have different impacts on your business that you should carefully consider based on the income that you have and the income that you hope to be getting in the future.
In some ways, these legal grey areas can allow you to move forward with your app or website development in ways that work for you but in other ways, they create dangerous areas that need to be carefully navigated.