Gimme Shelter Uncle Sam can't solve your Y2K problems, but new tax deductions may make it easier to afford the protection you need.

Making sure your company is Y2K-prepared doesn't start andend with updating your computer systems. You can also reap taxsavings for making those corrections and adjustments. The IRSrecently issued an announcement indicating that companies candeduct the cost of modifying or converting their existing softwareto make it Y2K-compliant.

The new IRS provision includes the costs of using eitherin-house personnel or an outside firm to search through thesoftware code and fix any date-related problems within existingsoftware programs. It's important to keep in mind, however,that the announcement doesn't cover the purchase of newsoftware or hardware, says Gary Juhnke, a CPA and tax partner withDeloitte & Touche LLP. Different tax provisions apply in thosecases, as we discuss later in this column.

Joan Szabo is a writer in Great Falls, Virginia, who hasreported on tax issues for more than 13 years.

Know Your Options

Entrepreneurs actually have two tax-saving options for deductingthe costs of Y2K-related software fixes. First, you can deduct allthe costs of making your software Y2K-compliant in one lump sumfrom the current year's income no matter what year the changeswere made. The second option is to treat the cost as a capitalsoftware-development expense and amortize the cost over a five-yearperiod. But you can't do both.

What factors should you consider when deciding which option toselect? It boils down to whether your business would be better offtaking one large deduction in one year or spreading the cost outover five years, says Susan Jacksack, a tax attorney andsmall-business analyst with CCH Inc., a Riverwoods, Illinois,provider of legal, tax and business information. Jacksack is theauthor of CCH Business Owner's Toolkit Tax Guide 1999, apublication designed to help small, single-owner businesses preparetheir 1999 income tax returns.

While deducting your Y2K-related costs in a single year meansthe money you save will be more quickly available to use for otherbusiness purposes, there are situations in which having more cashright now isn't as important as other considerations. Oneexample, says Jacksack, is the business owner who's gettingready to sell his or her business and has to meet certain financialratios under a covenant with a bank. If he or she wants to avoidlarge fluctuations in the company's financial statements,amortizing Y2K-related computer costs over five years is likely tobe the more attractive option.

You'll also need to anticipate future developments for yourbusiness. If you expect to receive a large contract in a year orso, for example, it may make greater tax sense to utilize thefive-year option, Jacksack suggests.

Another factor that will influence your decision has to do withhow you've treated capital software-development expenses in thepast. If you've always amortized such expenses, the IRSrequires that you treat Y2K costs in the same manner. If you decideto alter the overall way you treat capital software-developmentexpenses, you have to file Form 3115 during the tax year in whichyou make the change.

Out With The Old

What if you decide to replace your computer system with anentirely new one? At this point, you'll get no special oradditional tax relief for taking such a step, although the usualsoftware and hardware depreciation schedules will still apply. Thisgenerally means you can amortize the cost of new software over a36-month period, starting with the first month you begin using thenew system.

Another option available to entrepreneurs purchasing newhardware is the expensing provision, or what's known as theSection 179 deduction. This provision allows you to write off up to$19,000 in new equipment for the 1999 tax year. The limit increasesto $20,000 next year. If you decide not to use this option, you canstill depreciate the cost of the new hardware over a five-yearperiod.

Keep in mind, however, that if you sell the equipment after youclaim the expensing provision or stop using it in your business assignificantly as you initially claimed it for, you may have torecapture, meaning give back, part of the tax benefits youpreviously filed, says Jacksack.

What if the system you purchase comes loaded with software? Inthat case, it's treated as a single item for tax purposes--theIRS views the software as an integral part of the hardwaresystem.

Remember, if you only buy new software, you can't take animmediate write-off because the IRS treats software as intellectualproperty, says Jacksack. Software by itself must be written offusing the software and hardware depreciation schedule. Theexception to this rule relates to software that becomes obsolete inless than a year, such as annual tax preparation software.

Juhnke warns that the IRS is expected to thoroughly scrutinizeY2K-related deductions. When making changes for Y2K compliance,carefully document your expenses, being sure to give detailedexplanations of why you needed to make various software andhardware changes. Jacksack also recommends getting a guarantee inwriting from the company you buy any technology-dependent productfrom that the product is Y2K-compliant.

More Deductive Reasoning

You may also be able to deduct other expenses you incur in theprocess of making your business Y2K-compliant. Such expensesinclude seminars on solutions to the problem and travel costsassociated with attending these seminars. You can even deduct thetravel costs of going from store to store to compare the costs ofnew computer systems. And if you take out a business loan to payfor the cost of fixing your existing computer system or to buy anew one, the interest on the loan is deductible.

If you're able to find an insurance carrier willing to offeryou protection against business losses due to Y2K-complianceproblems--whether they're caused by failures in your computersystem or one outside your business--the cost of that coverage isalso deductible. (Finding such insurance is highly unlikely,however. See the February 1999 "Insurance" column formore on this topic.)

What if a Y2K-related problem somehow causes physical damage toyour company? It's possible to claim a casualty loss in somecases, such as if your business is burglarized as a result of analarm system failure. However, Jacksack notes, the claim is subjectto the usual rules for casualty losses, which don't includelosses incurred because of a slowdown in business activity or adecline in business reputation. (For details, see IRS publication#547, Casualties, Disasters and Thefts).

Is More Relief On The Way?

For many entrepreneurs, existing tax relief might not besufficient to help correct their Y2K problems. As it is, mostbusinesses already use up the Section 179 expensing deduction eachyear on new equipment purchases they need to grow their businesses,says accountant Debbi-Jo Horton of DJ Horton & Associates inEast Providence, Rhode Island.

To provide entrepreneurs with a little more tax relief,there's an effort under way in Congress to offer smallcompanies greater deductions under Section 179. Sponsored by Rep.Karen L. Thurman (D-FL), The Businesses Undergoing the Glitch (BUG)Act (H.R. 179) would offer small-business owners a deduction of upto $40,000 for the purchase and installation of Y2K-complianthardware and software acquired in 1999.

Thurman says her legislation is needed to encourage smallcompanies to purchase Y2K-compatible equipment now before it'stoo late. In addition, under the bill, small-business owners whopurchased Y2K-compliant equipment in 1997 and 1998 would be allowedto accelerate depreciation up to $40,000 for that equipment.

During the last Congressional session, Rep. Thurman's billmade it through the Oversight subcommittee of the House Ways andMeans Committee. She's optimistic that it will make headwaythis year as lawmakers become even more aware of the Y2K-complianceproblems facing small-business owners.

Making computers Y2K-compliant and receiving tax deductions toboot should be a high priority for entrepreneurs this year. Takinga wait-and-see approach is a dangerous strategy. Says Jacksack,"If you lose business because your systems aren'tcompliant, that's your own loss and it can't be recouped[through the tax code]."

That's Entertainment

Restoring a lost tax break

Congressional efforts are underway to provide entrepreneurs withsome tax relief. A bill introduced in the House would partiallyrestore the business and entertainment meal deduction, increasingdeductibility from the current 50 percent to 80 percent. The boostwould take place gradually over a six-year period, rising 5 percenteach fiscal year starting in 2000.

Ten years ago, businesses were permitted to deduct 100 percentof business meals as necessary business expenses. In 1987, thededuction was cut to 80 percent, and then reduced again in 1994 to50 percent. When the business meal and entertainment deduction wascut, small businesses suffered, says House Small Business Committeechair Jim Talent (R-MO), co-sponsor of the bill. Restoring aportion of the deduction, he says, will represent an important stepin ending "an unfair and punitive policy."

To show your support for H.R. 1195, contact your congressperson.The "find your reps" feature at http://www.congress.org can help putyou in touch. Or if you already know your congressperson by name,call the U.S. Capitol switchboard at (202) 224-3121 and ask to betransferred.

Contact Sources

CCH Inc., see listing for page 36

DJ Horton & Associates, (401) 435-4988, http://www.dj-horton.com