From developing environmentally friendly buildings to navigating complex design requirements, architects and engineers routinely drive growth, innovation, and societal progress through their work. Each year, the Research and Development (R&D) Tax Credit saves businesses hundreds of thousands of dollars for performing such activities—but this powerful opportunity for tax savings is often overlooked by architects and engineers.
As 2015 drew to a close, the R&D Credit entered a new era of expanded usefulness for many businesses, including architecture and engineering firms. Although the credit was created in 1981, the 2015 tax year marked the first year that it was a permanent part of the tax code. Previously, the R&D Credit’s goal of spurring technological innovation in the U.S. had been stymied by a pattern of nearly annual expiration followed by renewal. However, the Protecting Americans from Tax Hikes (PATH) Act of 2015 finally made this popular incentive permanent.
The PATH Act also modified the R&D Credit to make it more available to small and medium-sized businesses, including architecture and engineering firms. Previously, business taxpayers were only able to use the R&D Credit to offset their income tax liabilities. Beginning in 2016, however, certain businesses with an average of $50 million or less in gross receipts over the past three years will now be able to apply the R&D Credit toward their alternative minimum tax (AMT) liabilities. In addition, the PATH Act extended the R&D Credit to newer businesses that have been in operation for less than six years, had no gross receipts for the five preceding tax years, and have gross receipts of $5 million or less in the current year. These businesses may use the R&D Credit to offset their FICA payroll tax liabilities. For these taxpayers, the amount of the credit is limited to $250,000 and cannot exceed the FICA liability during a given quarter.
Traditionally, many architecture and engineering firms have wrongly assumed that the R&D Credit only rewards groundbreaking innovation and scientific research and is, therefore, unavailable to them. However, since the IRS relaxed the rules for claiming the credit in 2003, this valuable incentive has been widely applicable to taxpayers in these industries. A four-part test determines which activities constitute qualified research:
• The purpose of the activity must be to create new or improve the existing functionality of a business component. Many activities that architects and engineers commonly perform in the course of their business operations satisfy this prong of the test. Examples include developing designs that incorporate energy efficiency measures or account for unique client requirements, site conditions, or building codes.
• The taxpayer must intend to eliminate uncertainty that exists at the outset of the project. Typically, architects and engineers encounter many variables at the beginning of a project, such as what the optimal design will be and which materials should be used. Seeking to resolve these variables fulfills this requirement.
• The project must involve a process of experimentation that is designed to evaluate one or more alternatives. Architects and engineers often test different design concepts through computer modeling, engineering calculations, and other activities that may satisfy this prong.
• The process of experimentation must be technological in nature and must rely on the physical or biological sciences, engineering, or computer science.
The taxpayer’s savings under the R&D Credit are based upon qualified research expenses (QREs), which include wages paid to employees and other amounts expended in the conduct of qualified research. Any claim of the credit must be supported by meticulous documentation of the amount of time employees spent working on the qualifying activity, how much they were paid, records demonstrating that the activity satisfied the four-part test, and more.
With the expanded opportunities now available to architecture and engineering firms under the PATH Act, now is the time for businesses in these industries to consider the R&D Credit as a lucrative tool in their tax strategies. Capital Review Group has extensive experience in helping architects and engineers determine if they qualify and harness maximum savings with the R&D Credit. Contact CRG today for a pro bono analysis!