By David Jean, CPA, CCIFP, CExP, of Albin Randall & Bennett
Published March 8, 2021
Business owners from all walks of life look for ways to increase cash flow and maximize savings in times of economic uncertainty. For construction companies today, hiring new employees, investing in new products and services, or expanding operations may have drifted out of focus or feel out of reach. Wouldn’t it be great to have access to immediate cash and dollar-for-dollar tax savings to reduce tax liability? With the R&D Tax Credit, this may not be wishful thinking.
The federal R&D Tax Credit was established to keep jobs and innovative ideas in the U.S. and solidify our nation as a key player in the global economic field. To promote growth, development, and job creation closer to home, most states, including all New England states, also offer R&D tax credit incentives. Since the federal credit has evolved a great deal since its introduction in 1981, there are still many common misconceptions. My goal is to clear up some of these misconceptions and help construction companies understand what activities and expenses qualify for the credit.
Clearing Up Common Misconceptions about the R&D Credit
Research and development only occurs in labs and is mainly performed by industry titans – Not true. Expenses paid for improvements you make in your day-to-day operations may qualify for the credit, regardless of your company’s size.
The amount saved is based on revenue – Not true. The amount saved is based on eligible expenses for the credit. In 2015, the PATH Act expanded the credit, allowing businesses and start-ups of all sizes the opportunity to utilize the credit to lower their tax liability.
Innovation must be revolutionary to qualify – Not true. In 2003, the “Discovery Rule” calling for research activities to be “new to the world” was eliminated, so construction companies can now claim the credit for research activities that are new only to the company itself.
The expenses and credit claimed can be limited for the year – Not true. If all activities and related expenses qualify, there’s no limitation on the expenses and credit you can claim each year.
The credit only helps in the current tax year. Not true – You may be able to file an amended return to receive an immediate tax refund from previously filed returns, and the refund could potentially include interest.
How can construction companies determine which activities and expenses qualify?
For your innovation to be considered a Qualified Research Activity (QRA), the activity must rely on an applied science, such as engineering, physics, or chemistry, and the process must include testing and evaluation procedures. In general, improvements or developments made to products, processes, formulas, and software qualify.
If your construction company designs or develops new structures or building components, the expenses related to these activities are often eligible for the R&D Tax Credit. Development of new or improved electrical or HVAC systems may qualify. And, even if they are temporary, innovative systems involving shoring may qualify. “Green building,” developing sustainable designs, energy-efficient projects, and experimenting with new building materials may be eligible too.
Improving or developing processes or techniques can qualify as QRAs. Routine procedures and engineering and aesthetic changes made after a component has been commercially produced are examples of activities that are not QRAs.
To determine R&D Tax Credit savings, construction companies have to determine Qualified Research Expenses (QREs) related to their QRAs. QREs can include wages paid to employees performing services related to a QRAs and the cost of related supplies. Third-party expenses for contract research, such as amounts paid to hired consultants for engineering and design services or testing, may qualify as well. To benefit fully from the credit, construction companies need to track and document their developments and related expenses. Among other things, supporting documentation may include payroll records, general ledger expense detail, project notes, blueprints, designs, and test reports.
Eligible and Qualified Small Businesses
Small construction companies may qualify for additional benefits provided by the PATH Act. If your company meets the Eligible Small Business (ESB) standards, including being a non-publicly traded corporation, a partnership, or a sole proprietorship and having average annual gross receipts of $50 million or less for the last three taxable years, you may be able to use the R&D Tax Credit to offset Alternative Minimum Tax (AMT). ESBs can claim credit in the current year and over a three-year lookback period. If your company has had gross receipts for five years or less and meets the Qualified Small Business (QSB) standard of $5 million or less in annual gross receipts, you may be able to use the credit to offset your Federal Insurance Contributions Act (FICA) portion of payroll taxes, up to $250,000 each year for up to five years.
David Jean, CPA, CCIFP, is a firm principal and the Practice Leader of the Albin Randall and Bennett (ARB) Construction & Real Estate, Succession Planning, and Business Advisory Services Groups. Jean specializes in financial accounting and consulting for construction, real estate, and manufacturing companies. He serves on the National Association of Surety Bond Producers (NASBP) Certified Public Accountant Advisory Council, an exclusive group of construction CPAs who serve as a resource team for NASBP. He can be reached at djean@arbcpa.com and 207.772.1981.