Project-related obstacles present themselves daily. Navigating these obstacles is integral to a company’s success. While plotting the appropriate course to accommodate the seen and unseen obstacles is handled during design and preconstruction, it’s inevitable that issues will crop up during construction. Designing and engineering solutions to these obstacles may feel like normal day-to-day business, but those activities are the key to potentially dramatic tax savings through the research and development (R&D) tax credit.
The R&D tax credit incentivizes companies to invest in R&D by allowing them to claim a percentage of their qualified research expenses over a base amount as a credit. Qualification rests on satisfying a simple four-part test:
- R&D must have been undertaken to discover certain information, the application of which is intended to be useful in the development of a new or improved business component
- Research must be technological in nature, such as engineering-based research
- The information sought must be intended to eliminate uncertainty concerning the development or improvement of a business component
- A process of experimentation should be used to eliminate uncertainties
Examples of Qualified Activities
- Design and development of electrical, HVAC and energy-efficient systems
- Design and development of unique buildings, structures and related components
- Design and development of unique temporary systems such as shoring, falsework and dewatering systems
- Development of new or improved processes, methods and techniques used in the construction process
- Design-build construction
- Value engineering
- BIM modeling
- Design for LEED/green initiatives
These activities are generally carried out in concept design, schematic design, design development and value engineering phases of projects. Qualified activities may extend into the construction, testing and startup and commissioning phases where systems or structures need to be physically built to confirm design success.
Qualified Research Expenses
Qualified research expenses fall into three categories: wages, supplies and contract research.
- Qualified wages relate to employees involved in qualified research activities. These are the in-house personnel carrying out design and development activities. Qualified employees generally include designers, drafters and engineers.
- Qualified supplies are defined as tangible personal property used in the conduct of qualified research activities. Materials or components related to prototypes or testing are the most common type of qualified supply expense. Examples of qualified supplies include test structures, prototype components and experimental structures or systems.
- Qualified contract research expenses are incurred when a third party is contracted to carry out research activities on your behalf. Examples of contract research include outside design or engineering professionals or independent contractors used to assist with a project.
Taxpayers are required to maintain documentation sufficient to substantiate the R&D tax credits being claimed. The first step is to document the business component being developed. The business component for construction and engineering projects is often the design of the property built for the customer. The design could relate to an entire building or, more commonly, one of its subcomponents or subsystems, such as HVAC, plumbing, electrical, etc. The business component also could relate to an infrastructure project, such as a bridge or heavy highway project.
The second step is to document the design and evaluation process. This is achieved by identifying documentation that highlights unique technical requirements of the design and how various alternatives were developed and evaluated. Documents created during the concept design, schematic design, design development and value engineering phases are often the most helpful. Companies also can create project narratives that summarize the issues and challenges faced and how these were overcome.
Funded research projects are excluded from tax credit consideration, as funded research indicates the company doesn’t have financial risk related to the research. Construction, engineering and architecture firms may feel that all of their work is funded research; however, this isn’t necessarily the case. Contract terms and conditions must be reviewed to determine who bears the financial risk of the research.
Current case law teaches us that cost-plus and time and materials contracts are generally considered funded research. These contracts place the financial risk on the customer, as they’re paying for the research efforts. On the other hand, fixed-fee contracts aren’t considered funded research. Under fixed-fee contracts, contractors are often obligated to deliver a successful product or design for a set price. This shifts the financial risk from the customer to the contractor.
The company claiming the R&D tax credit also must retain substantial rights to the research results. This determination is made by concluding which party retains ownership over designs, processes and related intellectual property.
Qualifying for Credits
Construction, engineering and architecture firms can qualify for R&D tax credits. To determine eligibility, companies should first evaluate the types of projects undertaken and the related contracts. If you have fixed-fee contracts related to design and engineering, please contact your BKD trusted advisor or complete the Contact Us form below.