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Tax Treatment of Year 2000 Costs

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On November 10, 1997, the Internal Revenue Service released Revenue Procedure 97-50, in which the IRS set forth its views as to the proper tax treatment of expenses paid or incurred to modify computer software to avoid the so-called "year 2000 problem."

Summary

The IRS recognizes that numerous taxpayers may incur considerable expense in modifying or replacing computer software to correct the so-called "year 2000 problem," arising because many computer programs utilize a two-digit, as opposed to four-digit, field to represent the year component of dates. In fact, the IRS recently estimated its own bill to become Y2K compliant will be about $1.6 billion!

In Revenue Procedure 97-50, the IRS states that costs paid or incurred to convert existing software, to develop new software to replace existing software, to purchase or lease new software to replace existing software or to develop or purchase software tools to assist in converting existing software ("year 2000 costs") should be treated just like any other computer software costs in accordance with the rules of Revenue Procedure 69-21.

Thus, the IRS will not challenge a taxpayer's treatment of "year 2000 costs"

  • To develop software or software tools, if the taxpayer either expenses those costs or capitalizes and amortizes them over a 60-month period (or such shorter useful life of the software as the taxpayer can clearly establish) consistent with the taxpayer's treatment of other computer software costs,
  • To purchase software or software tools, if the taxpayer capitalizes and amortizes those costs over a 60-month period (or such shorter useful life as the taxpayer clearly establishes) unless those costs are "bundled" with computer hardware costs, in which case the "year 2000 costs" should be included in the hardware cost, or
  • To lease software or software tools, if the taxpayer expenses the software rental payments.

The IRS also notes that due to the nature of "year 2000 costs" such costs will not be eligible for the research credit of Internal Revenue Code section 41, "except in those extraordinary circumstances in which those costs satisfy the definition of 'qualified research' in § 41(d) and otherwise meet all the requirements of § 41."

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