What expense category is Data Backup and Recovery Services?

In today's digital world, a company's data is one of its most valuable assets. Protecting that data from loss due to hardware failure, cyberattacks, or natural disasters is a critical business necessity. Services that provide data backup and disaster recovery are therefore an ordinary and necessary expense for almost every modern business.

For tax purposes, it's important for accountants and business owners to understand that these recurring service fees are typically deductible in the year they are incurred. This guide explains how to categorize these costs in accordance with IRS rules, what records are required, and how to track them efficiently.

Data Backup and Recovery Services Expense Category

The IRS does not have a specific line item for Data Backup and Recovery Services. However, based on the principles outlined in IRS publications, these costs are deductible operating expenses. 

Because you are paying a recurring fee for the use of remote servers and software infrastructure that you do not own, these costs are best classified as:

• Rent or Lease Expense: As defined in IRS Publication 535, rent is an amount you pay for the use of property you do not own. Fees for using a provider's cloud storage and server infrastructure for backup fall squarely into this category.
• Dues and Subscriptions: This is another common and appropriate classification for ongoing service fees.

Important Considerations When Classifying Data Services

The key to correctly handling these costs is to distinguish between paying for a service and buying a capital asset.

Service Subscription vs. Hardware Purchase

• Backup Service: Monthly or annual fees paid to a third-party provider for cloud backup or disaster recovery services are currently deductible expenses.
• Purchased Hardware: If you buy physical assets for your own backup system, such as servers, external hard drives, or tape drives, these are considered capital expenditures. According to IRS Publication 946, you cannot deduct the full cost upfront. Instead, you must capitalize the cost and recover it over time through depreciation (typically as a 5-year property under MACRS).

The Prepayment Rule

As with other subscriptions, if you pay for a multi-year data backup or recovery service contract in advance, you cannot deduct the entire payment in the year you make it. IRS Publication 535 requires you to prorate the expense and deduct only the portion that applies to the current tax year.

Bundled IT Services

If your data backup services are part of a larger managed IT service contract, the portion of the fee attributable to backup and recovery is deductible. The invoice or contract should ideally break down the costs for different services provided.

Examples of Data Backup and Recovery Expenses

Deductible as a Current Expense:

• Monthly fees for a cloud backup service that automatically backs up your company's computers and servers.
• Annual subscription fees for a Disaster Recovery as a Service (DRaaS) platform.
• Fees paid to an IT consultant to manage and monitor your backup systems.

Must Be Capitalized and Depreciated:

• The purchase of a network-attached storage (NAS) device or server for in-house backups.
• The cost of physical tapes and drives for an archival backup system.

Tax Implications and Recordkeeping

To deduct these service fees, you must report them correctly and maintain the required documentation.

How to Report the Deduction

For a sole proprietor filing a Schedule C (Form 1040), data backup and recovery service fees can be deducted in Part II, Expenses. The most appropriate lines are:

• Line 20a (Rent or lease - Vehicles, machinery, and equipment)
• Line 27a (Other expenses), listing them as "Data Services" or Software Subscriptions.

What Records to Keep

The IRS requires you to keep supporting documents for all your business expenses. For data backup and recovery services, these records should include:

• Invoices and service agreements from your provider.
• Monthly or annual statements detailing the services and charges.
• Proof of payment, such as credit card statements or canceled checks.

How Fyle Can Automate Tracking for Data Service Expenses

Fyle automates the tracking of recurring IT service subscriptions, ensuring every payment is captured and categorized correctly for tax compliance.

• Capture Recurring Payments: Fyle’s real-time credit card feeds instantly record every subscription payment from your existing business cards.
• Automate Categorization: Set up rules to automatically code all payments to your backup provider to the correct IT Services or Rent/Lease expense category.
• Centralized Invoices: Service invoices emailed from your provider can be forwarded to Fyle and automatically attached to the matching transaction.
• Sync with Your Accounting System: Fyle integrates directly with QuickBooks, Xero, NetSuite, and Sage Intacct to automatically sync categorized expenses to the correct GL account.