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June 13, 2013

Contractors, you too can get R&D tax credits

  • Construction companies are creating innovative designs and new construction processes, both of which can lead to R&D tax credits.
    • By STAR FISCHER and SHANE HUNT
    Moss Adams LLP

    Fischer

    Hunt

    The Research & Experimentation Tax Credit, commonly known as the R&D tax credit or the research credit, is a valuable credit companies can leverage to lower their tax liability and increase cash flow.

    But mention R&D to most people, and they immediately think of doctors or rocket scientists wearing white lab coats. The truth is, businesses in many industries frequently do work that qualifies for significant R&D tax credits — and the construction industry is no exception.

    A great example is the work many construction companies are doing to solve the challenges of incorporating structurally innovative and energy-efficient products into their project designs. As technology creates better, stronger and more efficient materials, construction companies are finding ways to do things better and faster. This means creating innovative designs and new construction processes, both of which can lead to a company qualifying for the R&D tax credit, which rewards companies for taking on some extra risk.

    It's important to note, however, that the credit is not just for companies developing “new-to-the-world” products and processes; companies developing a product or process that's new to their company through qualified activities may also claim the credit. These tax credits can also be retroactive. Depending on when a tax return was filed, companies may be able to go back and claim it for the three prior years.

    The biggest opportunities in the construction industry are often found in design-build and LEED projects; however, any project with technically challenging elements that require engineering and a process of experimentation for evaluating other alternatives can potentially qualify for the R&D tax credit.

    Many different types of construction companies may be able to qualify for the credit, including general, mechanical, electrical, civil and specialty contractors. Eligibility largely depends on whether the work you're doing meets the criteria established by the IRS through its four-part test:

    1. Uncertainty test. You must demonstrate that you've attempted to eliminate uncertainty about the development or improvement of a product or process.

    2. Process of experimentation test. You must demonstrate — through modeling, simulation, systematic trial and error, or other method — that you've evaluated the alternatives for achieving the desired result.

    3. Technological test. The process of experimentation must rely on the hard sciences, such as engineering, physics, chemistry, biology or computer science.

    4. Qualified purpose test. The research's purpose must be to create a new or improved product or process, resulting in increased performance, function, reliability or quality.

    While qualified activities can be found throughout a construction project, most are performed in the design phase, because the conceptual and engineering design work contains most of the uncertainty and related evaluation. Uncertainties include:

    • The type of layout to be used.

    • The capabilities the structure needs to have.

    • The type of structural components and materials that would work best to obtain the desired results and functionality of the structure.

    • How the various components fit and function together in order to achieve the desired results.

    All technical uncertainties of a project may not be possible to eliminate in the design phase and can carry forward into the construction phase. For example, new construction materials, such as a newly designed HVAC system or concrete forming process, may need to be installed and tested in a real-world environment before the uncertainty of the design is eliminated. This could be done on the first two floors of a building before being replicated throughout the rest.

    Under certain circumstances a component may need to be fully constructed and the project completed for the uncertainty to be eliminated in the design. The commissioning or testing of the completed project can be the final test that a new energy-efficient HVAC system is able to achieve the desired results.

    A few examples of projects, activities and initiatives that may be eligible for the R&D tax credit are:

    • Developing new or improved products or processes to address unique energy-efficient features.

    • Developing innovative designs for bridges, dams and roadway structures.

    • Designing new or improved products or processes for renewable energy infrastructure.

    • Developing new or improved construction techniques.

    • Designing new or improved products or processes for mechanical or electrical systems related to unique structures.

    • Experimenting with new material combinations and evaluating their performance properties.

    As with many tax incentives, there are specific guidelines and requirements for how the R&D credit is calculated and supported.

    Prior to August 2012, the R&D credit was considered a Tier 1, or top priority, issue with the IRS. As such, the IRS released specific guidelines on how qualified activities are identified, calculated and supported.

    Although the tiered system has since been eliminated, many of the rules and directives issued regarding the credit must still be followed during an IRS examination.

    It's important to discuss the R&D credit and its application with your tax accountant before filing your annual tax returns.

    Star Fischer, CPA, is senior manager and chair of Moss Adams' Research and Development Tax Credit Group. Shane Hunt is a manager and part of R&D Tax Credit Group.



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