Just by doing what comes naturally for cutting-edge AEC firms, they are likely eligible for a refundable tax credit.
Every day, architecture and engineering companies create innovative designs to delight their clients and respond to the every-changing regulatory and efficiency requirements. Being agile and innovative keeps these companies at the forefront of their industry and creates repeat clients.
Just by doing what comes naturally to these cutting-edge companies, they are likely eligible for a refundable tax credit. The R&D tax credit is calculated based on the expenses spent to perform the development and research necessary to create their designs. The credit is activity based, not success based, meaning the research can be unsuccessful and the taxpayer may still claim the credit. The expenses are typically employee wages or contractor costs, and are compared to prior years’ R&D expenses. The credit is roughly the increased spending year over year.
Of course, the tax code, regulations, and court cases interpreting the statutes explain the requirements to claim the credit. The activities must qualify as research, the taxpayer claiming the credit must pay for the performance of the activities, and must retain the intellectual property rights to the research.
As an initial inquiry, activities claimed as part of the credit calculation must qualify as research. The code defines research as a four-part test, specifically:
The activity must be technological in nature. The activity must be based on principles of the following hard sciences:
- Computer science
- Physical sciences
- Biological science
The activity must be for a permitted purpose. The activity must involve the creation of a new or improved level of:
- Cost reduction
The activity must involve the elimination of uncertainty. The activity must explore what was not known at the start of the project:
- Capability uncertainty – Can we develop it?
- Methodology uncertainty – How will we develop it?
- Design uncertainty – What is the appropriate design?
The activity must involve a process of experimentation. Substantially all of the activities must include elements of experimentation:
- Evaluating one or more alternatives
- Performing testing or modeling
- Examining and analyzing hypotheses
- Refining or abandoning hypotheses
- Determining alternative structural design including analysis of and experimenting with structural components, building materials, occupancy load, building use, environmental pressures, safety, soil, and site considerations
- Assessing design through various forms of modeling and computational analysis
- Determining alternative materials with which to construct a structure or parts of a structure (e.g. pre-stressed concrete, glass)
- Analyzing land, grade, and soil conditions
- Developing alternate utility designs
- Determining alternate means of assembling or fastening component parts of a structure
- Developing alternative water flow or plumbing systems
- Improving or determining appropriate ventilation for a structure
- Designing systems for communications, alarm, lightning protection, grounding, and instrumentation and control
- Developing alternative electricity conduction systems
- Conducting energy modeling for assessing energy efficient designs
- Developing or improving lighting within a structure
- Improving acoustical qualities of a structure
- Analysis of environmental impact
- Integrating toxic waste and other waste disposal processes into the structure
- Designing systems for improving heating, cooling, humidifying/dehumidifying, cleaning, ventilating, and component integration for optimal effectiveness
Capturing your R&D expenses takes know-how and compiling substantiating documentation. It can provide cash and permanent tax savings to your company. For example, an architectural firm had revenue of about $3 million and paid $500,000 in qualified wages toward research activities. These qualified expenditures will yield a federal credit of about $50,000.
Contact CTA to quickly determine if you are a candidate for the R&D tax credit or for more information.
Jessica Creevy, director of tax controversy at CTA. Jessica has more than 11 years of experience in tax controversy. She worked as an estate and gift tax attorney at the IRS before moving into private practice representing companies and individuals in front of the IRS and various state taxing authorities. Jessica holds a master’s of law in taxation from the Strum College of Law, University of Denver. Contact her at firstname.lastname@example.org or 256.262.7230.