Issue 10 - August 2003

Finance & taxes by Mark Battersby
Programming your software deductions

Today software is embedded in virtually every aspect of your chiropractic practice. Surprisingly, however, it took the Internal Revenue Service more than 30 years to update its procedures concerning deducting the cost of that all-important computer software.

What’s so difficult about deducting the cost of the software used in your chiropractic practice? The tax law’s complexity comes into play when you consider all of the ways in which there are to acquire that software. For example:

• Off the shelf. Many chiropractors buy software programs right off the shelf and use them out of the box.

• Special development. Others hire programmers to modify that stock software or to create computer programs expressly for their practices.

• Bundled systems. Others may acquire software that is included as part of a computer system, a phone system or the chiropractic practice’s billing or accounting system.

• ‘Inherited’ programs. Still others acquire software along with the other assets of a practice that they’ve purchased or acquired.

Each type of software expenditure requires its own unique tax treatment.

Complicating matters further, tax regulations offer you some flexibility in tax write-off strategy — either spreading the deduction over time or taking an immediate “hit.”

As you think about how to approach software deductions, you need to understand that the IRS will rarely disturb your accounting treatment for computer software development, acquisition or leasing costs — so long as that treatment is consistent and complies with IRS tax rules.

Deducting for developing software
Bascially, if you are into developing software (or hiring someone to develop it), you have a choice: Immediately deduct the costs of developing the software (whether for your practice’s own use or for sale to others) or amortize development costs over a five-year (60 month) period.

In fact, you can choose a short amortization period if appropriate. The key to the deduction is consistency — you have to treat all software costs, year-after-year, in the same manner.

Now for the good news/bad news:
The good news is that the Jobs and Growth Tax Relief Reconciliation Act of 2003 impacts on software deductions and you can get a break. For software acquired after May 5, 2003, you can get a unique “bonus” depreciation deduction equal to 50 percent of the expenditure.

The bad news? The new depreciation provision is both temporary (it applies only to software purchased between May 5, 2003 and before January 1, 2005) and limited — it applies only to software for which depreciation is elected.

And you have options. You can spread the software development deduction over a period of years (to offset future higher earnings and taxes) or take an immediate write off (to reduce a currently high tax bill).

Acquisition deductions
Not everyone develops software. But virtually all chiropractors buy software. When it comes to software acquisition, the tax rules ask only how you acquired the software that you are trying to claim as an expense.

If you obtained that software in the acquisition of another practice —or its assets — that software is classified as a so-called “Section 197” intangible and can only be written-off over a 15-year period.

If, as is more often the case, you acquired the software “off-the-shelf,” you depreciate (write off) the cost over a three-year period using the straight-line method of equal deductions each month of the 36-month period.

Changing accounting methods
You may want to change accounting methods, to take advantage of the new tax laws. If you change the way you treat costs to develop, purchase, lease or license software and adopt IRS guidelines, you must follow Form 3115, “Application for Change in Accounting Method,” and include the statement, “Automatic change Filed Under Sec. 8.01 of Rev. Proc. 2000-50.” (However, a change in useful life under one of these methods is not a change in method of accounting.)

Naturally, accounting adjustments for the year of change, as reported on Form 3115, may also result in a change in the tax bill for that year.

The new tax law — although temporary and limited — makes this a prime time to take a look at how you and your chiropractic practice treat software costs. Changing accounting methods has never been easier and the results could lower your tax bill for years to come.

Mark E. Battersby is a tax and financial advisor, freelance writer, lecturer and author with offices in suburban Philadelphia. He can be contacted at 610-789-2480.