By designing impressive new buildings and developing solutions for challenging structural issues, architects and engineers serve as beacons of growth and innovation in society. Yet, many architecture and engineering firms do not realize that their routine activities may qualify them for a powerful opportunity to significantly boost their bottom lines: the Research and Development Tax Credit.
As one of the most lucrative incentives in the federal tax code, the R&D Credit saves large companies billions of dollars every year. However, many smaller and medium-sized businesses miss out due to the common misconception that the R&D Credit is available only to taxpayers that spend vast amounts of capital on R&D or engage in high-tech or scientific research. In reality, the credit is available to businesses of all sizes in a wide variety of industries, including architecture and engineering — and, due to changes under the Protecting Americans from Tax Hikes (PATH) Act of 2015, it is now more valuable for smaller and newer businesses.
What Is the R&D Credit?
The R&D Credit was added to the federal tax code in 1981 with the goal of spurring innovation in the U.S. Until 2015, the credit was not a permanent part of the tax code but was, instead, subject to Congressional renewal each year. Fortunately, the PATH Act made the R&D Credit permanent and allowed certain businesses to use it against tax liabilities other than income tax — which has expanded the credit’s utility for many smaller businesses. Specifically:
- Businesses that have averaged $50 million or less in gross receipts over the past three years may now apply the credit towards their alternative minimum tax (AMT) liabilities.
- Businesses that have been operating for fewer than six years, had no gross receipts for the previous five tax years and have $5 million or less in gross receipts for the current year may use the R&D Credit against their FICA payroll taxes.
This dollar-for-dollar tax credit is available to businesses that engage in qualified research activities. To constitute qualified research, a taxpayer’s activities must fulfill the following criteria:
- The goal must be to create or improve the functionality of a product, process or software;
- The taxpayer must seek to resolve some uncertainty about the activity, such as its optimal design or the best method for completing the project;
- In striving to eliminate the uncertainty, the taxpayer must complete a process of experimentation designed to evaluate one or more alternatives; and
- The process of experimentation must be technological in nature and rely on the physical or biological sciences, engineering or computer science.
- For architecture and engineering firms, a few examples of activities that may be considered qualified research include:
- Developing designs that include energy efficiency measures or accommodate unique site conditions, municipal codes, or client requirements
- Incorporating new design or construction techniques
- Performing engineering calculations
- Evaluating and testing designs through modeling, computational analysis, informal trial and error, or other means
- Performing construction planning
How to Claim the R&D Credit
To claim the R&D Credit, businesses must provide thorough documentation of qualified research activities, including project lists and cost summaries, tax returns, and the payroll records and time sheets for employees who engaged in R&D. The R&D Credit amount is based on the taxpayer’s qualified research expenses (QREs), which are the costs that a business incurs — such as employee wages and amounts paid for supplies — while conducting qualified research.
In addition to the federal credit, most states offer their own tax incentives for businesses conducting R&D activities. For example, Arizona’s R&D Credit is equal to 24 percent of a taxpayer’s first $2.5 million in QREs, plus 15 percent of QREs more than $2.5 million. Qualified research must be conducted in Arizona and must comply with the requirements for the federal credit.
Based on routine activities that they conduct in the course of their business, many architecture and engineering firms may find that they are eligible for tens or even hundreds of thousands of dollars in tax savings at the state and/or federal level. In light of the changes under the PATH Act, now is the time for businesses in these industries and many others to consult their tax professionals and determine whether they may be eligible for this valuable incentive. With the potential savings available through the R&D Credit, businesses can cut their tax bills and boost their net profits, thereby powering future growth and innovation.
Jordan Taylor is lead advisor for Capital Review Group, a leading incentive/tax advisory firm based in Phoenix that specializes in maximizing tax savings for businesses in various industries, including architecture, engineering, and manufacturing, as well as commercial building owners. Its team of tax experts stays current on the latest laws and IRS regulations affecting business taxpayers. Capital Review Group also partners with CPAs, CFOs and other tax and financial professionals to help them develop customized tax strategies that harness drastic savings for their clients.