A construction company claiming a Research and Development (R&D) credit, really? That’s a common response many people have when they first hear about the R&D credit in relation to the construction industry. The reality is, a large number of construction companies are performing R&D that qualifies for a credit in the eyes of the IRS. The problem: many don’t realize it, due in large part to common misconception. This article will shed light on the R&D credit, specifically in the context of the construction world, in order to help businesses determine if they may qualify to claim this highly beneficial credit.
What is the Research and Development Credit?
The R&D credit is a federal credit (also available in many states, but that is out of scope for this article) which allows applicable businesses to claim a credit for a percentage of their qualified domestic spending on R&D. The credit was originally enacted in 1981, but lived a life of uncertainty for almost forty years as it floated along with temporary status that was inevitably renewed tens of times as its expiration would arrive. Then in December of 2015, Congress passed legislation that both expanded the R&D credit and made it permanent.
How does a company qualify for the R&D credit?
In order to qualify, a company must look at their activities on an individual project level and determine if a given project meets what is called the “four-part test.” The four-part test consists of, you guessed it, four separate qualifiers that the project must meet in order to qualify for the R&D credit. Here is a brief overview of each of the four tests:
- Permitted purpose: The activity must be intended to develop or improve the functionality, performance, reliability, or quality of a business component (product, process, technique, formula, invention, or software).
- Elimination of uncertainty: The activity must be intended to discover information to eliminate technical uncertainty concerning the capability or method for developing or improving a product, or process, or the appropriateness of the business components design.
- Technical in nature: The activity must be one of the “hard sciences” to qualify, which in the case of construction, almost exclusively means Engineering.
- Process of experimentation: Substantially all of the activities must be elements of a process of experimentation. These must involve the evaluation of more than one alternative to achieve an uncertain result.
Once it is determined that a project meets the four-part test, the qualifying expense categories can be extracted from the project and applied toward the credit. This is a very broad overview of the process and does not encompass all of the detailed aspects of the calculation. The actual analysis should be performed by an individual that is experienced with the credit calculation.
Application of the R&D credit to the construction industry
By this point, you may be saying “I’m still not sure what meets this four-part test and how this applies to the construction industry!” And that is a reasonable reaction, as the rules are not worded to directly identify construction activities that qualify. As such, there are a number of possible activities in the construction industry that generally meet this four-part test:
- Developing prototypes and modeling
- HVAC and electrical concept and system design
- Development of new, improved, or more reliable products, processes, or techniques
- Design work for LEED or energy efficient projects
- Custom design work to accommodate visual or structural needs
- Development of a unique assembly or construction method or process
- Experimentation with new building materials
The above overview is designed to help construction companies identify if they may be performing activates that qualify for the R&D credit. The information in this article is not designed to provide a platform for a company to perform calculations with, but rather serve as a general overview. We recommend consulting with your tax advisor so that your specific situation can be properly assessed.