With the constant discussions surrounding COVID-19, there could be positive news for construction companies. More construction companies are taking advantage of the Credit for Increasing Research Activities (R&D tax credit) than ever before to realize potentially substantial savings in the process.
Although COVID-19 hasn’t directly altered the R&D tax credit, below are examples of why now is an opportune time to pursue this credit:
- May result in immediate cash savings to improve liquidity.
- Construction companies are seeing an increase in capacity of their employees.
- It would be advantageous to pursue the credit during a time when employees have capacity to focus on this value-driving incentive.
What is the R&D tax credit?
Since the 1980s, the R&D tax credit has been claimed by many industries, including manufacturers, software developers, chemical companies, technology companies and pharmaceutical companies. Recent court cases have supported the position that construction companies, engineering firms and architectural firms are also able to reap the benefits of R&D tax credit incentives. The tax incentive comes in the form of a federal tax credit that offsets tax liabilities dollar-for-dollar. In addition to the federal credit, many states have R&D tax credits of their own. The combination of these incentives can potentially provide major savings for companies that qualify.
How can construction companies qualify for the R&D tax credit?
The R&D tax credit is an incentive designed to encourage businesses to invest in developing new or improved processes, techniques and products. Most contracts have unique customer requirements, resulting in many construction companies performing these exact functions for their customers on a daily basis. Below are examples of activities that construction companies often conduct that may qualify for the R&D tax credit:
- Designing and developing unique solutions or designs
- Exploring alternative designs to determine which ones best meet the customer’s needs
- Designing building systems (HVAC, electrical, plumbing) to improve efficiency
- Exploring opportunities for value engineering and cost savings
- Utilizing building information modeling (BIM) or alternative design software to evaluate designs
- Designing drainage and water management systems
Materials and Construction Processes
- Exploring alternative materials or combination of materials to determine which material best meets the customer’s needs
- Exploring alternative means and methods of construction or development of innovative assembly techniques
- Development of designs or techniques that achieve certifications or standards, such as Leadership in Energy and Environmental Design (LEED), etc.
- Modifying original plans or designs to work around requests for information (RFIs) as they arise during construction
The above list is not all inclusive. Most contractors have various activities they conduct which may meet R&D qualification criteria.
Below are two examples of qualifying activities:
- A contractor is engaged to design and construct a unique structure for a customer that involves technical uncertainties surrounding the design of the structure and the means of assembling the structure. The contractor must go through an iterative process 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.
- A mechanical contractor is contracted to design and install an HVAC system in a food processing plant. The plant 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 can construction companies pursue the R&D tax credit?
DHG’s process for pursuing the R&D tax credit involves the following phases:
Scoping (Cost / Benefit Analysis)
The first phase in an R&D tax credit pursuit is identifying if the contractor has qualified activities and then estimating the cost associated with each activity. This analysis is usually performed by working with key employees 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 are able to be amended. In addition to estimating the overall benefit, this step includes evaluating the information available to document the activities and estimating the cost of pursuing the benefit. This allows the contractor to minimize the investment in the exploration of the opportunity until the overall benefit and cost of pursuing is determined.
Execution of the R&D tax credit study
Executing the R&D tax credit study involves capturing actual qualified costs for the various qualified activities, using the qualified costs to calculate the R&D tax credit, obtaining project specific supporting documentation to prove qualification (design plan iterations, engineering change orders, testing documentation, images, etc.) and interviewing subject matter experts or project managers to document the projects in order to demonstrate qualification. The end result of this phase is the applicable R&D tax credit forms and a packaged deliverable designed to support the R&D tax credit claimed both quantitatively and qualitatively for purposes of the Internal Revenue Service (IRS) and state audits.
Filing tax returns / amending prior year returns
After the R&D tax credit study is completed, the tax returns can be filed or amended and will include the applicable federal and state R&D tax credit forms. The R&D tax credit can directly offset tax owed, and cash savings are often realized immediately with an originally filed return. If an amended return is filed, then the IRS will process the amended return and issue a refund of taxes previously paid, if applicable.
Potential IRS or state audit
Given the significant cash savings of many R&D tax credit claims, there is potential for the R&D tax credit to be audited by the IRS or state taxing authority. If the contractor’s R&D tax credit is audited, 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 for the credit and the process used for calculating the company’s R&D tax credit. The IRS requires extensive documentation to support an R&D tax credit claim. Having a thoroughly documented R&D tax credit study is instrumental in navigating IRS and state audits.
Construction companies performing activities such as those highlighted above, even under contract, should certainly evaluate the R&D tax credit opportunity. The savings for many contractors are significant enough to allow them to be more competitive when bidding on jobs, as they can utilize the R&D tax credit to offset a portion of the job costs. To avoid potential scrutiny under IRS examination, it is crucial to utilize an acceptable methodology for computing and documenting an R&D tax credit claim. Capturing the cash savings is generally well worth the time and effort required in determining eligibility and pursuit of the R&D tax credit.