When the topic of research and development (R&D) tax credits is discussed, chemists with lab beakers typically come to mind. In reality, it’s more accurate to envision construction superintendents and engineers in hardhats on a jobsite. More construction companies are taking advantage of the credit than ever before and are realizing substantial savings in the process.
Recent changes in applicable law have allowed construction companies, engineering firms and architectural firms to reap the benefits of R&D incentives that come in the form of a federal tax credit to offset tax liabilities dollar for dollar. In addition to the federal credit, most states have R&D tax credits of their own. The combination of these incentives can provide major savings for qualifying companies.
The R&D tax credit is an incentive designed to encourage businesses to invest in developing new or improved processes, techniques and products. Following are some activities construction companies often conduct that may qualify for the R&D tax credit.
Developing unique solutions or designs; exploring alternative designs to determine which best meet the customer’s needs; designing HVAC, electrical and plumbing systems to improve efficiency; exploring opportunities for value engineering and cost savings; utilizing BIM or alternative design software to evaluate designs; and designing drainage and water management systems.
Materials and Construction Processes:
Exploring alternative materials or a combination of materials to determine which best meets the customer’s needs; evaluating alternative means and methods of construction or development of innovative assembly technique; and developing designs or techniques that achieve certifications or standards (e.g., LEED, BREEAM, NBIS).
For example, a precast contractor may be engaged to design and construct a unique structure for a customer that involves technical uncertainties surrounding the design and assembly. To qualify the activity, the contractor must go through an iterative effort to develop a design that meets the customer’s many functional requirements. In addition, the contractor must explore alternative methods to assemble the structure due to space constraints.
In another example, a mechanical contractor is contracted to design and install an HVAC system in a food processing plant that requires unique temperature controls and condensation limitations. The mechanical contractor is uncertain of the appropriate design of the HVAC system to meet these requirements and must evaluate various designs to identify the appropriate solution.
How to Obtain the Credit
Once the contractor has performed qualifying activities and then estimated the associated costs, the next step is to work with higher level vice presidents who have visibility over the entire organization and its activities. This exercise provides information needed to estimate the contractor’s overall R&D tax credit benefit available for the current tax year, as well as prior tax years that can be amended.
Next, contractors should execute an R&D tax credit study, which involves capturing actual qualified costs for the various qualified activities, obtaining project-specific supporting documentation to prove qualification (e.g., design plan iterations, engineering change orders, testing documentation and images) and interviewing subject matter experts or project managers to document the projects and demonstrate qualification.
The end result of this phase is a packaged deliverable designed to support the R&D tax credit claimed both quantitatively and qualitatively for purposes of Internal Revenue Service (IRS) and state audits.
After the R&D tax credit study is completed, the tax returns can be filed or amended with the applicable federal and state R&D tax credit forms. The R&D tax credit will directly offset the tax owed, and cash savings are often realized immediately with an originally filed return. If an amended return is filed, then the IRS must process the amended return and will issue a refund of taxes previously paid.
Prepare to Be Scrutinized
Given the significance of many R&D tax credit claims, the R&D tax credit potentially could be audited by the IRS or state taxing authority. For an audit, the contractor will be notified by the respective taxing authority (IRS or state), and the taxing authority will request information that demonstrates the company’s eligibility and the process taken for calculating the company’s R&D tax credit.
The IRS requires extensive documentation requirements to support a research credit claim. Having a thoroughly documented R&D tax credit study is necessary to avoid the IRS disallowing all or a portion of the company’s claim.
To avoid potential scrutiny under IRS examination, it is crucial to utilize an acceptable methodology for computing and documenting an R&D tax credit. With the U.S. corporate tax rate currently being among the highest in the world, companies are always seeking opportunities to lower their tax burden and effective tax rate. The R&D tax credit is one way to do that.
Capturing the cash savings is well worth the time and effort. The savings for many contractors are significant enough to allow them to be more competitive when bidding on jobs, as they can count on the R&D tax credit to offset a portion of the job costs.
Adam Quattlebaum is a senior manager and the R&D Tax Practice Leader at Dixon Hughes Goodman LLP. For more information, email email@example.com.