The Research and Development Tax Credit -- How It Applies to the Construction Industry
by Daniel Shepherd, CPA and Deyna Rouse, CPA; LUTZ
Businesses are continually seeking ways to improve their profits by providing new and improved products to compete in the economy, and this applied to the construction industry as much as any other. The Research and Development (R&D) Tax Credit was created to encourage U.S. companies to conduct domestic research and development. This credit has been in effect through December 31, 2013 and is expected to be extended again for 2014 and beyond.
For a business to qualify for R&D tax credits, its activities must meet the “4 Part Test” as set forth in Income Tax Regulations:
- The activity must be intended to eliminate technical uncertainty related to the development or improvement of a business component.
- The taxpayer must also evaluate one or more alternative solutions, which are unknown at the beginning of the research.
- The process must include discovering information that is technical in nature (rely on principles of physical sciences, such as engineering, biology or computer science).
- The process must provide a new or improved business component (examples: new product, technique, formula, invention or software).
Conventional wisdom holds that typically only manufacturers or software developers may qualify for R&D credits, but many construction, architecture and engineering firms may qualify as well. Some examples of qualifying activity may include:
- Development of a new or improved construction technique
- Design/engineering of new, unique or improved customer solutions
- Development of LEED/Green/Sustainability solutions
- Development of unique, new or improved HVAC, mechanical, electrical, plumbing solutions
- Development/engineering of new, unique or structural solutions
This credit does come with its own set of limitations due to technical issues and underlying tax utilization rules. One of the biggest potential risk factors associated with claiming the R&D credit is the increased audit risk for taxpayers within the construction, architectur, and engineering industries claiming the credits. Secondly, specific contract terms may often impact whether or not projects would be considered eligible for the credit. For example, cost-plus type contracts are less likely to qualify for credit, due to the reduced risk of loss incurred by the contractor under the terms of the contract. However, lump sum design/build contracts may qualify.
The overriding factor to consider is the taxpayer’s (or its shareholders’, in the case of flow-through entities such as partnerships and S corporations) ability to utilize any credits generated. Prior to incurring the cost of performing an extensive R&D credit study, the contractor should consider consulting its tax professional to determine the likelihood of utilization to make sure that the calculating and filing for the credits is cost-beneficial. Many opportunities for R&D credits may exist for contractors, particularly those with more exposure to design/build-type contracts and LEED-certified projects, so consultation with a trusted tax professional is advised to determine if an R&D study is right for you.