In its original form back in the 1980s, the Research & Experimentation (R&E, R&D or research) tax credit applied to the construction industry rarely or not at all because the “discovery test” was in place, which required the qualified activity to be something that was “new to the world.” But changes to the tax code between then and now have opened this credit up to a wide variety of industries, including construction, MEP contractors and consulting engineering firms.

The R&E tax credit is a federal tax credit for the development or improvement of products, processes, formulas, techniques, inventions and software. It also applies in approximately 40 states. At the federal level, every $100,000 in qualified research expenditures (QREs), equates to around $6,000 in dollar-for-dollar federal tax credits. As a result of corporate tax reform, this will increase to approximately $7,000 starting with the 2018 tax year.

So what are the requirements? There is a four-part test that projects must satisfy for the associated expenditures to qualify for the R&E tax credit.

1. The business component test defines eligible project types as a new or improved product, process, formula, technique, invention or software.
2. The research needs to be based on the hard sciences or engineering as opposed to cosmetics or aesthetics.
3. The project must have uncertainty in one of the three categories of capability, method or design. That could mean uncertainty in the capability to achieve a faster, more efficient construction method to develop the design of a new building or to make improvements to an existing design.
4. There must be a process of experimentation. The tax code mentions modeling, simulation and systematic trial and error as acceptable forms of experimentation. CAD modeling, BIM simulations and iterative design development are often seen as qualified activities in the construction industry. The graphic below illustrates the types of construction project activities that may typically qualify for the credit.

Qualifying expenditures fall into three categories: wages, supply costs and contract research. Eligible wages are for employees who are directly engaged in the research activity, supervise research (only direct reports) or indirectly support research (such as preparing lab and test reports). Supply costs include materials directly consumed in the research process such as test materials and those used for mock-ups. Contract research includes expenditures associated with third-party activities including 1099 contractors engaged in design work as well as external resources such as consulting engineers. The graphic below shows the employee job titles that typically have qualified research wages for the credit.

Along the way, there are a few clarifications to the qualification of activities for the R&E tax credit. One is the concept of economic risk. If the contractor is able to invoice the customer for projects on a time and material basis then, in R&E terms, the company does not have economic risk for this project. However, if a project is bid on a fixed price basis, then the company holds the economic risk.

Another important factor is that the construction company retains substantial (not exclusive) rights to the research. If the customer is granted all rights to the design on a project, the construction company is not able to claim the expenditures associated with that project. Finally, the research activities have to take place in the United States.

Along with the above description of what is required for the credit, there are also things that come to mind when thinking about R&D that are not required. First, a traditional R&D lab is not required. Innovation can happen anywhere and often does. For example, even with plan and spec projects that are supposedly designed to 100 percent, project managers and superintendents often come up with design improvements onsite. Some of these may be proactive (finding a better way to do something) while others might be reactive (caused by unanticipated site conditions). Second, success is not required. In fact, the R&E tax credit world is one in which the more iterations there are, the better.

The R&E tax credit is a powerful incentive to innovative companies in many fields, including the construction industry.