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As the COVID-19 pandemic persists, many Orange County construction companies and contractors are looking for new ways to generate cash flow. The conversation often focuses on new product development, enhanced marketing, or cost management, but little attention is given to tax-saving opportunities. While many are focused on COVID-19 related breaks such as the Employee Retention Tax Credit (ERC), it is important not to forget about the compelling saving opportunity available through the R&D tax credit. Although contractors are often aware of it, many believe the credit is only available to companies with formal research and development departments or projects. This is simply not the case, as the credit can be claimed on many construction-related projects. To help clients, prospects, and others, JLK Rosenberger has provided a summary of the key details below.
What is the R&D Tax Credit?
The Research and Development tax credit applies to a wide range of qualified research expenses (QREs). In exchange for creating or improving a product, process, technique, formula, or invention, the R&D credit allows contractors to reinvest in the company. In a field where contractors are designing innovative approaches to building construction and utilizing new, state-of-the-art software, there are many ways to benefit from the R&D credit.
How to qualify for the R&D Tax Credit:
To qualify, a project must meet the four-part test in Section 41 of the Internal Revenue Code. In summary, this means that a qualifying project:
- Must have uncertainty surrounding the capability, method, or procedure to complete the project.
- Must rely on the hard sciences, including (but not limited to) engineering and chemistry.
- Follow a process of experimentation.
- Intend to create a new or improved structure, system, or pipeline system.
There are two calculation options to use depending on the circumstances: the traditional method or the alternative simplified method. Certain contractors can claim the credit against their alternative minimum tax (AMT) obligations or payroll.
The R&D credit can be used to offset AMT if the company has:
- Average gross receipts of $50 million or less over the last three years, and,
- Is a private corporation, partnership, or sole proprietorship.
The R&D credit can be used to offset payroll taxes if the company has:
- Gross receipts of less than $5 million for the current tax year,
- Gross receipts going back five years or less, and
- A private corporation, partnership, or sole proprietorship.
Note that a small contracting company may have been in business longer than five years ago to qualify for the payroll tax offset, but its gross receipts cannot go back longer than five years.
R&D Tax Credit Benefits
There are several benefits to claiming the R&D tax credit, including:
- A net dollar-for-dollar tax credit to offset federal (and most state) tax liability.
- Ability to claim the credit retroactively for up to three years.
- Credit carryforward up to 20 years.
Typically, the R&D credit can generate anywhere between 6 and 12 percent against qualified expenses. When companies can go back up to three years to claim unused credits and potentially apply portions of the credit to offset AMT or payroll taxes, that means a substantial amount of cash flow to reinvest in critical business operations.
There is a wide range of qualifying R&D activities in construction. Since COVID-19, technology has been at the forefront of every industry, including construction. And the continued focus on energy efficiency and sustainability, it is likely there are R&D activities already happening.
Consider the following list of potential activities as a starting point.
- HVAC, electrical, LEED, Net Zero, and other energy-efficient design and building activities.
- Prototypes, modeling, and testing.
- Designing advanced building solutions and structural systems for use in changing and challenging environments.
- Experimenting with new or different building material combinations.
- Utilizing Building Information Modeling (BIM) for sub-system coordination.
- Developing or improving construction equipment.
- Preparing structure and facility designs for constructability
- Performing Request for Information Processes (RFIs)
- Analyzing the functions of a design to improve performance or quality.
What if our project fails?
It is important to remember that a project does not need to be successful to claim the R&D credit. If it meets the four-part test, it qualifies. The following types of expenses qualify for the R&D credit.
- Taxable wages for employees directly involved in research activities (except management).
- Cost of supplies, including utilities beyond normal charges.
- A substantial portion of contracted research expenses if the research was performed by a third party and retain ownership rights and bore the financial risk.
When a project is done at the behest of a third party or as part of a larger contract, there are additional considerations for qualifying research expenses – and who owns the research and bears the financial risk.
It can take time to evaluate whether a project qualifies for the R&D credit and which calculation method will provide the best return. Even construction companies that already claim the R&D credit may be missing the full scope of qualified activities. For this reason, it is important to work with a qualified advisor who can guide efforts. If you have questions about the information outlined above or would like assistance with another tax issue, JLK Rosenberger can help. For additional information, call us at 949-860-9902 or click here contact us.