Originally created 08/15/98

A possible silver tax lining for companies



WASHINGTON -- Companies struggling with Year 2000 computer problems may find a silver tax lining with the IRS, but some questions cloud the issue - such as how to qualify for the best deductions.

The Internal Revenue Service says it will allow full tax deductions -- in a single year rather than the usual three -- for businesses that have to repair or convert existing software. Deductions for improvements beyond fixing the millennium bug, however, still fall under the three-year rule, the agency's guidelines say.

But there is much uncertainty about precisely what that means -- and thus, many fear the matter could result in thousands of legal tax fights.

"It's going to be a fine and fuzzy line between improving your software and converting it," said Hannah Carvey, a Washington tax attorney. "When you actually get into it, there's very little you can buy that doesn't actually improve your system."

It is generally better for the taxpayer to fully deduct a cost from income taxes over one year, rather than three or more, because all the money is more quickly available for other purposes.

For businesses across America, the Y2K problem, as it's known, threatens to disrupt everything from payroll data to computer-controlled sprinkler systems.

The IRS says businesses can deduct the costs of dealing with the problem on one important condition: the costs must be incurred in the repair or conversion of existing software.

Individuals who are able to deduct expenses because they use their home computers for business purposes or run a company from home fall under the same IRS guidelines as companies.

The Y2K problem affects computer programs written to recognize only the last two digits of a year. This was commonly done when storage and memory were extremely expensive, and programmers could saved both by using just the last two digits.

The problem is that these computers will falsely read the year 2000 as the year 1900, wreaking havoc with all kinds of data.

Some estimate it could cost companies worldwide as much as $600 billion to bring their computers into compliance, including $300 billion in the United States. The flaw was carried into many of the estimated 40 billion microchips now in use.

"It can disrupt a company's business, cause financial loss and give rise to legal liability," said Bruce Fox, a Chicago attorney who is advising businesses on how to deal with the problem.

So companies are busy trying to figure out the best way to make their systems Y2K compliant. One of the factors involved is how the solutions will affect a company's tax bill.

The IRS last year acknowledged the special nature of the tax problem by issuing guidance linking the situation to a 1969 ruling involving computer research and development costs. The agency said it "will not disturb" a taxpayer's full, one-year deduction of the costs, so long as the costs involve conversion, not the purchase of new software that may improve existing systems in other ways.

Without more definitive instructions, some tax advisers say companies will purchase software that fixes the Y2K problem and attempt to deduct it -- only to have the IRS dispute the claim because the software also makes other improvements.

Final disposition of the cases could take years and prove even more costly.

"Their guidance is skeletal," Carvey said. "They are inviting litigation."

While much attention on Capitol Hill has focused on the federal government's attempts to deal with Y2K in its own agencies' computers, Congress also is beginning to notice the tax dilemma facing private business.

The House Ways and Means Committee is considering legislation by Rep. Karen Thurman, D-Fla., that would make it easier for small businesses to fully deduct Y2K costs.

The measure, endorsed earlier this month by a subcommittee, would more than double the one-time deductions that small businesses are allowed for capital costs such as desks or computers. The idea is to raise the limit high enough so that smaller businesses can immediately write off their Y2K costs in one year, regardless of the IRS definition.

"This is an expense you certainly don't get a benefit for," Fox said.