December 2000

Domain names - What you must know about their tax treatment

hen buying or selling a domain name, how does a business treat the sale for federal tax purposes? At this stage of the game, no definitive rules have been written, however, many tax advisors are treating domain names like trademarks. Yet, this is perhaps not a completely accurate way of dealing with them. Domain names have certain characteristics that set them apart. At some point, the government will likely step in and make some definitive decisions about their tax treatment.

A question of value

From a tax vantage point, products and services are considered in terms of value. In looking at domain names, this is the best place to begin. A domain name has two types of value:

1. product, service or company reputation value; and,
2. intrinsic value.

To the degree that a domain name enhances a product, service, or company reputation, its value is like that of a trademark for tax purposes. However, the so-called intrinsic value of a domain name has nothing to do with image or reputation and should not be viewed as a trademark for tax purposes.

In order to better understand the complexity of this issue, it is useful to look at existing trademark laws.

Trademark law 101

"Trademarks and service marks are words, names, symbols, or devices used by manufacturers of goods and providers of services to identify their goods and services, and to distinguish their goods and services from goods manufactured and sold by others." (Brinson & Radcliffe, An Intellectual Property Law Primer)

For trademarks used in commerce, federal trademark protection is available under the federal trademark statute, the Lanham Act. Many states have trademark registration statutes that resemble the Lanham Act, and all states protect unregistered trademarks under the common law of trademarks. Trademarks have value to the extent they give rise to actual or potential commercial advantage for the owner.

Tax treatment of domain names

IRC §197 deals with deductions related to intangible assets purchased for use in business. The purchase of a domain name falls under this category. Generally, an intangible covered by this code section is deducted over a fifteen-year period.

Trademarks are §197 intangibles, and the definition of the term is broad enough to include domain names.

Where a domain name operates as a trademark, it qualifies for §197 tax treatment. If a domain name has inherent value (which is a separate asset), this aspect of the name does not meet the definition of trademark and does not warrant the same tax treatment.

"In general, however, it is important to note that even when a domain name is not deemed a trademark, it can still be considered an asset that can be amortized or capitalized for deduction purposes," says Jim Riedy, partner, McDermott, Will & Emery, Washington.

Until the tax laws change, this is the best way to handle domain names when determining their value for tax purposes.

IRS plans

Though it was not listed as one of the IRS' action points in its current business plan, we can expect to see them address the subject of domain names and their tax treatment in the near future, explains Riedy.

Editor's note: Riedy can be reached at (202)756-8314.