How to Classify Domain Name Sales Income for Tax Purposes: Developing a Defensible Tax Strategy

If you—as an individual or business—sell a domain name, would the gain on the asset sale be taxed under the capital gains rules as a gain on the disposal of an asset? What about if you trade in domain names for profit? Would the gain be treated as trading income for tax purposes?

As with much tax law, the answer is, it depends.

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Domain Name Tax Guide
Make sure you don't pay more taxes than you owe on domain name sales. Sandra Brooks specializes in tax planning for domainers.

In this invaluable book, Brooks outlines all the details you'll need for effective tax planning for entrepreneurs who buy and sell domain names.

Learn More About the Domain Name Tax Guide »
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Developing a Defensible Tax Strategy for Domain Name Sales Income

There are many issues to consider when figuring out how to handle income from domain name sales, and there are no definitive cases the IRS has dealt with specifically on this issue. Of course, you should discuss your particular situation with your tax accountant, but even your accountant may not understand the subtleties of the domain market, so be sure that you're prepared with enough information about similar industries and how they treat income or gains so that your accountant can develop defensible tax strategies that can save you thousands of dollars.

Domain Names and Tax Issues to Consider:

• Are domains considered owned or leased?
  It makes a difference in tax law whether you own the domain, as you would own say, a vacant lot, or is it a leased asset such as a telephone number? Some have argued that the yearly fee you pay to your registrar is a lease payment, and others say it's simply a fee that you pay to have the registrar manage the ownership records.
• Are you buying and selling domains as a business?
  If you're in the business of buying and selling domain names, the IRS will look at the income differently than they would if you occasionally buy a domain as a personal investment. H&R Block, for example, in answering a question about what form to use to report the gain on a domain sale, writes: "It depends on if the domain name was a business or personal asset. If business, use Form 4797. Otherwise report the sale on Schedule D." Schedule D is for capital gains. But it's not so simple.
• Should a domain name be considered as a "Trademark" for tax purposes?
  Depending on how you use a domain name, if it's generic or brandable, and what the brand value is of the domain name, you may have to treat the domain differently, and consider a portion of it more like you would a trademark for tax purposes. In this case, how is the income from the sale of a domain name handled?

Since domaining for profit is a relatively new business, the fact is that nobody really knows the rules, tax rules notoriously have a lot of gray areas. According to a recent article in Domain Informer, "domains could be intellectual property, inventory, business assets, government licenses, a form of real estate, or a host of other things. The truth is, nobody really knows yet how they should be treated, so together accountants and domainers are taking their best guess and hoping they don’t get audited."

There are no tax laws or tax court cases yet that relate directly to domaining. As a domainer, you need to understand your core business and prepare a solid and defensible tax policy that is a) based on existing tax code for similar industries, b) consistent, and c) well documented. Be proactive and you can ease your tax-time worries.

It's important for domainers to be consistent in how they treat domain income, to keep good records, and to have a tax plan from the start. Both you and your accountant should have a solid understanding of the domain business, and knowledge of existing tax laws for similar industries and how they can pertain to domain name sales. From there, you can have a defensible tax strategy that provides you with the most advantageous tax treatment for your situation.

In this new industry, there are few resources that specifically address domaining and tax law. There are some informal discussions that can be found in domaining and webmaster forums on the topic of tax issues for domainers, but they tend to raise more questions than they answer.

With competent professional tax advice costing about $150 per hour, it's a good idea to be well prepared.

It's important to start a consistent strategy early on in your domain business, so your initial purchases and expenses are correctly classified from the start. For an excellent overview of the domain business and tax strategies and options, and a clear presentation of the issues and how to develop a defensible tax strategy, I highly recommend a publication such as The Domain Tax Guide, by CPA, Sandra Brooks (85-page eBook, $79).

There's also a hardcover book by David Hardesty called Electronic Commerce: Taxation & Planning (hardcover, $270), which covers a wide range of tax issues around electronic commerce in general, though the section about treatment of domain names for tax purposes is relatively limited.

Resources:

• The Domain Tax Guide