In 1981, the federal government established the R&D tax credit to encourage investment in research and development in the private sector that would lead to innovation. This credit is a way of rewarding intangibles — creativity and inventiveness — because these things result in a stronger national economy. Unfortunately, fewer than one out of 20 business owners who are eligible for this credit actually claim it on their tax returns, forgoing millions of dollars worth of tax savings every year. Small and midsized companies especially tend to make this mistake. Some 2015 changes in the tax code make this credit easier and more profitable than ever to claim. If you own or manage a company in the construction industry, here are the details about a tax credit you can’t afford to ignore.
How the Tax Credit Works
One important point to be aware of is that this is not a tax deduction; it is a credit subtracted directly from the amount of tax your business owes. The actual calculation and documentation of your tax credit amount is not a simple DIY operation, however, and may be the reason so many businesses overlook this ready source of cash.
Companies developing processes, principles, products, methods or materials that are new and innovative can claim this credit, which discounts their tax debt dollar-for-dollar. In addition to crediting the actual outcome of completed innovation, the tax credit also supports business decisions to invest in a research and development process. In other words, the credit is available to your company for efforts at innovation, regardless of the success of that research. Claims for the credit are retroactive up to three years, and companies are allowed to defer the credit for up to 20 years.
Credit works against both the federal and state tax liability.
The Credit's History
First enacted in 1981, the R&D tax credit has had a fluctuating presence in the business landscape. In 2007, an Alternative Simple Credit (ASC) offered businesses a simpler avenue to managing the complex calculations. In 2013, President Obama reinstated the lapsed credit as part of his American Taxpayer Relief Act and made it retroactive to the beginning of 2012. Taxpayers can now decide whether they prefer deducting R&D expenses as they are incurred or amortizing those expenses over the course of at least five years.
A change in R&D tax credit rules announced by the Treasury Department in January 2015 contained important new modifications. These rules broaden the standards of what constitutes research activities, opening the door for many new business activities to qualify for the credit. The 2015 change also allows you to claim the credit on amended returns covering the last three years. That new look-back provision increases the ROI for the accounting time you need to assemble the documentation to qualify for the credit. Submitting amended returns for past years means that the pay-off will be larger, as you are refunded taxes from previous years.
Some businesses in the construction industry view their own development processes as a form of R&D and fall into the trap of not realizing their tax credit eligibility. Research and development, in the eyes of the IRS, does not have to result in a patent application or trademarked process. Innovations developed through pure creativity, such as an architect’s building design or an electrical system developed to work around the metal components of a building’s structure, are examples of qualifying activities.
The following 3 categories of expenses will determine the size of the credit:
- Wages paid to your own employees for R&D-related services
- The cost of supplies used in the R&D process
- Fees paid to an outside contractor providing your company with R&D services
As you read the three categories of expenses above, the next obvious question is: What services qualify as R&D? This question is important, since many employees are tasked with developing new methodologies and more streamlined production processes. Below are the four criteria the IRS uses to define research and development activities as they relate to the A/E/C industries:
- The research must be based on principles of an established hard science.
- The research must have a goal of improving functionality, durability or quality of a building structure.
- The previously existing technology or information must not provide any certain solutions to the problem being addressed. In other words, your research must be making an effort to break new ground.
- A documented process of experimentation or trials must be engaged in as a way of testing your solution to the previously existing uncertainty.
Although the documentation requirements for claiming this credit can be substantial, they become much more straightforward when you review the list of non-qualifying activities. This list includes such expenses as marketing, cosmetic building appearance, zoning compliance activities, normal quality control testing and other steps in the building process.
Tax savings Across the A/E/C Industries
As the demand for energy efficiency and green building processes increases, the opportunities for claiming the R&D tax credit are drastically expanding. Contractors collaborate with architects and engineers as they engage in countless eligible activities. These activities include the development of structural design innovations, schematics, and assessment of alternative materials and engineering systems. One environmental engineering firm profiled in Accounting Web realized a tax saving of over $524,000 for its redesign of a failed section of sewer line. An electrical contractor developed a new method of integrating the building's wiring with metal structural materials and qualified for over $450,000 in tax credits.
The R&D tax credit, designed to keep American industry at the cutting edge of innovation, is a virtually untapped source of extra cash for construction-related businesses of all sizes. Working together with your accountant, you can strengthen your company's dynamic response to changing conditions in the construction industry.
For more information, contact Allan Peiser at 214.635.2503, or one of our other experienced professionals.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.