There are innovators in every industry, including construction. If your company happens to be one, you may be able to claim the research tax credit, which remains available under the Tax Cuts and Jobs Act.
To be eligible, an innovation-seeking business activity generally must do several things. First, it must relate to development or improvement of a “business component,” such as a product, process, technique or software program. It also needs to strive to eliminate uncertainty over how (and whether) the business component can be developed or improved.
In addition, the company must exercise a “process of experimentation,” using techniques such as modeling, simulation or systematic trial and error that relies on “hard science,” such as engineering, computer science, physics, chemistry or biology.
What might a contractor do to qualify for the credit? There are many possibilities. Safety is obviously a major concern in the industry. By developing safer and more efficient construction techniques and methods, you may become eligible.
Inventing a process to design buildings, features or systems that improve energy efficiency or facilitate LEED certification may also qualify. And if you happen to work in the HVAC, electrical, plumbing or lighting areas, original ideas your company uses to design or improve these systems may allow you to claim the credit.
Lastly, if your construction business is on the cutting edge of technology and involves itself in software design, it’s highly advisable to explore research credit eligibility.
Peruse your contracts
To claim the credit, you must bear at least some of the financial risk associated with the research and enjoy substantial rights to the results. Otherwise, the effort will be considered “funded research,” which is ineligible for the credit.
If you do research for a customer under a fixed-price contract, it may be more likely to be eligible for the research credit because you bear the financial risk of the work (provided you also retain contractual rights to the results). Try not to do research for a customer under a cost-plus or time and materials contract, because it may be considered funded research (which is ineligible because the financial risk remains with the customer).
Crunch the numbers
If your company does qualify for the research credit, it could receive a dollar-for-dollar, non-refundable credit of up to 6.5% of qualified research expenditures (QREs), which include wages and supplies related to qualified research activities, calculation costs and 65% of research fees paid to certain contractors.
“Nonrefundable” means the credit can’t exceed your tax liability for the year. So, you can’t use it to generate a loss and claim a refund over what you paid in taxes. But unused credits may be carried back one year or forward up to 20 years to offset those tax liabilities.
Calculating the credit is complex: There are several methods. Essentially, it’s equal to a percentage of the amount by which your current-year QREs exceed a base amount.
Remember, simply conducting research isn’t enough to qualify you for the credit. You’ve got to meticulously document how your company has established research activities and increased them in pursuit of an innovation. If you don’t, the IRS may say “no way.”
Case in point: In Harper v. U.S., a recent decision by the U.S. District Court for the Southern District of California, the sole shareholder of a construction company and his wife claimed the research credit on an amended tax return. They offered no proof other than an attachment that stated they were reporting a “credit for increasing research activity” in the amounts of $437,632 and $388,325 for two tax years. The IRS denied the credit.
The couple then brought a refund suit, submitting supporting documents. But the IRS still asserted that the refund claim failed to meet the eligibility requirements for the credit. The court agreed.
Talk it over
Claiming the research credit isn’t easy. But if you’re eligible, the tax savings and resulting cash flow boost can be worth the effort.
We welcome the opportunity to put our construction industry expertise to work for you. To learn more about how our firm can help advance your success, please contact Dave Wolfenden at (302) 254-8240.