The IRS offers tax credits for conducting “qualified research and development” activities. While this may not sound like something a construction firm could benefit from, the definition of qualified R&D activities is quite broad. Many common activities in the construction industry fall under the umbrella of qualified R&D activity and may qualify for tax credits under 26 U.S. Code Section 41 – Credit for increasing research activities, such as:
- Exploring means and methods and construction techniques
- Preparing structure and facility design for constructability
- Developing and improving construction equipment development
- Designing LEED/green initiatives
- Designing HVAC systems
- Designing electrical systems
- Using Building Information Modeling (BIM) for sub-system coordination
- Analyzing the functions of a design directed at improving performance, reliability, quality, safety and/or life cycle costs
- Improving mechanical equipment sizing
- Designing and testing custom software that improves the construction or project management process
- Modelling and testing project management tools designed for a specific client or project environment
- Designing and testing custom robotics that improve job site safety
- Utilizing Building Information Modeling (BIM) for coordination and planning
- We can hear the groans and see the eye-rolling from contractors on this one. We know. We’ve had BIM forced on us too. It did nothing but add cost and time to the project. But…there is a simple way to make the models useful and leverage them for productivity gains in the field. And the IRS will pay you to implement it.
The credit can be substantial. The amount can range from 9.1% to 20% of qualified expenditures, depending on who engages in the R&D (contract v. self-performed) and what calculation method is used.
The remainder of this article digs a little deeper into the code to get a sense of what expenses qualify and how to calculate the size of the credit. If you’re into that kind of thing, get your pocket protector and green visor out and dig in. If you’re not into green visors, feel free to contact us and we can talk like normal human beings (our apologies to the tax accountants reading the article).
About the R&D Tax Credit
The R&D Tax Credit, 26 U.S. Code Section 41 – Credit for increasing research activities, is a nonrefundable 20% or 14% tax credit, depending on the calculation you choose (your state may also offer a credit). There are three calculation options, discussed below in the “Three Calculation Methods” section. A “tax credit” typically means that you can reduce your tax liability dollar-for-dollar. However, you should keep track of qualifying R&D expenses even if you do not expect to owe taxes this year. There are two reasons:
- The credits generated under Section 41 can be carried forward 20 years or carried back three years. That is, you can bank the credits and claim them against future earnings, or receive a refund by filing an amended return and claiming them against past earnings.
- Smaller companies can get a payroll tax offset up to $250,000 of payroll. To be eligible, your company must have:
- Gross receipts for five years or less
- Average gross receipts not exceeding $5 million within the last five years
Only certain expenditures qualify for the R&D tax credit. Qualifying expenditures must meet the following four-part test:
- Permitted purpose: The activity relates to a new or improved function, performance, reliability, or quality of a product, process, computer software, technique, formula, or invention, which is to be held for sale, lease, or license or used in the taxpayer's trade or business (Secs. 41(d)(1)(B)(ii) and (d)(2)(B)).
- Technological in nature: The activity performed must fundamentally rely on principles of physical science, biological science, computer science, or engineering (Sec. 41(d)(1)(B)(i)).
- Technical uncertainty: The activity must be intended to discover information to eliminate uncertainty concerning the capability or method for developing or improving a product or process or the appropriateness of the product design (Sec. 41(d)(1)(A)).
- Process of experimentation: Substantially all of the activities must constitute elements of a process of experimentation involving (1) the identification of uncertainty concerning the development or improvement of a business component, (2) the identification of one or more alternatives intended to eliminate that uncertainty, and (3) the identification and the conduct of a process of evaluating the alternatives (through, for example, modeling, simulation, or a systematic trial-and-error methodology) (Sec. 41(d)(1)(C); Regs. Sec. 1.41-4(a)(5)(i)).
- In-house wages and supplies attributable to qualified research;
- Certain time-sharing costs for computer use in qualified research; and
- 65% of contract research expenses, that is, amounts paid to outside contractors in the U.S. for conducting qualified research on the taxpayer’s behalf.
Interestingly, software developed for internal use is specifically excluded from the R&D tax credit, unless it meets the following three-part test for innovation (taken from the final regulations issued by the IRS on October 4, 2016, Federal Register, Vol. 81, No. 192):
- The software is intended to be innovative as measured by a reduction in cost, improvement in speed, or other measurable improvement that is substantial and economically significant if the development is or would have been successful;
- The software development has significant economic risk in that the taxpayer commits substantial resources to the development and there is substantial uncertainty because of technical risk as to whether the resources can be recovered within a reasonable time; and
- The software is not commercially available, i.e., cannot be purchased, leased, or licensed and used for the intended purpose without modifications that would satisfy the innovation and significant economic risk requirements.
Three Calculation Methods for the Size of the Credit
There are three methods available to calculate the size of the credit. They include:
- Traditional Credit Calculation: provides a credit of 20% of the taxpayers qualified research expenditures that exceed a calculated base amount
- Start-Up Credit Calculation: provide a credit of 20% of the taxpayers qualified research expenditures that exceed a calculated base amount
- Alternative Simplified Credit: This calculation provides a credit equal to 14 percent of the current year qualified research expenses that exceed 50 percent of the average qualified research expenses for the 3 preceding taxable years.
Reach out to us today and find out how we can help you find productivity gains in the fields while earning R&D tax credits.
Steven Stelk, PhD, FP&A
Financial Strategist
Cycle Rate Performance
Comments
Post a Comment