While many tax breaks have been reduced or expired, Research and Development (R&D) tax credit has been in existence for over 30 years and recently made permanent. The R&D tax credit has generated over $12 billion dollars annually for companies engaging in research activities. While most Fortune 500 firms claim it, many in the construction industry erroneously believe they do not qualify. In fact, only about ten percent of eligible businesses actually take the R&D tax credit.
Even more surprising, many in the construction industry are unaware that the R&D tax credit, which is a dollar-for-dollar tax reduction, has gone through important changes that make it more valuable and easier for those within the construction industry to claim it.
How Is It More Valuable?
- Lower tax rates in 2018 have increased the value of the R&D tax credit by up to 14%.
- While new rules limit Net Operating Losses (NOL) to offset only 80% taxable income, the R&D credit can be used to offset taxes on the remaining 20%.
- The R&D tax credit can apply to payroll taxes for startup businesses (i.e., ones in operation less than 5 years).
- AMT is gone for corporations, allowing the R&D credit to be more accessible for individual owners of flow through business.
- The R&D tax credit is permanent.
What Expenditures Qualify for the R&D Credit?
Eligible expenditures for the R&D credit are the following:
- Wages paid to employees involved in the R&D process;
- Supplies used or consumed in the process of research; and
- Sixty-five percent of contract costs paid to others doing research.
For the above expenditures to qualify, the qualified research must satisfy a four-part test. The following example describes each component of this test.
- A contractor is tasked with creating a building that’s front façade has the least amount of structural obstruction to look sleek and provide a panoramic view on a hillside property. Its research process met the “elimination of uncertainty” test because the contractor was uncertain how to construct the building and what materials to use on a slope while meeting environmental and seismic issues, but still provide an unobstructed view structurally inside.
- The contractor’s project passes the “technological in nature” test because it relied upon geometry, engineering, mathematics and physics to determine what slope, angles, and materials would be needed.
- The research on the new process meets the “permitted purpose” test because it would create an innovative and new design that had not done before by the contractor.
- For the “process of experimentation” test, the contractor conducted a series of tests with different modeling software, drawings, consulted with outside architects and engineers to assist with positioning, testing, trying different types of metals, concrete applications and overall process of what and where to start building a foundation.
What Activities May Qualify for the R&D Credit?
- Engineering process and design
- Technical sales team meetings (determining specifications to bring back to engineering team)
- Green building or energy efficient design and improvement
- Quality approval & control (beyond routine testing and general inspection)
- Experimenting with alternative materials and metals to create a unique infrastructure
- Bid & quoting time for new and redesigned products
- Designing new or improved HVAC, plumbing or electrical systems for better flow, efficiency and usage
- Improvement or new process or best practices to increase efficiency or reliability
What Are Some Common Misunderstandings in Taking the R&D Credit?
1. We hire outside contractors to do the work, so it won’t be eligible for the R&D credit…
Many general contractors (“GC”) hire outside expertise to assist them with the validating a design or creating a design. If the GC has “financial risk” (meaning they are liable for any cost overruns or costs to fix errors or not being paid on level of effort) and rights (they reserve the right to know-how of the design), they may be able to take the costs paid to third parties as their own qualified R&D expenditures. Additionally, if they are paying a company for “testing or validation” of their design, they do not have to meet the two prongs above. For example, many GC’s today, have an engineering or architectural background, if they have to hire an acoustical engineer to test their design to insure it meets the client’s notice control standards, that is an R&D cost to the GC. Bottom line, as long as the GC is responsible for the ultimate success or failure of the design, they likely have eligible R&D costs.
2. We don’t have any licensed engineers or architects on staff, our work will not qualify.…
Taxpayers are not required to have a licensed engineer or architect, or even a formal education in a specific discipline. The construction industry has changed significantly over the past decade. Traditionally the GC or industry folks, merely built or oversaw plans to have a structure built. Nowadays, GCs and construction professionals often are involved in the design. They are assisting with what materials may work for the design, what the structural integrity of the building is, how to create an environmentally friendly building or how to make sure the building has the latest and newest innovation form conception. They are not merely following plans anymore but part of the team to find solutions and alternatives when a building code may not allow for the intended design or zoning may change the intended use of a property.
Construction professionals are becoming more innovative and are creating and improving processes, making them eligible for the R&D credit. While not all activities and projects will qualify, the R&D credit is worth considering as it could provide a lucrative benefit.
About the Author: Lacey Robb is the R&D Tax Credit Practice Leader for ICS Tax, LLC. She is an attorney and has an LLM in Taxation and has helped numerous taxpayers in a variety of industries take the R&D tax credit. She can be reached by phone at 310.968.0970 or by email at firstname.lastname@example.org. To learn more about the R&D credit and other specialized tax planning strategies, visit www.ics-tax.com.