The Benefits of R&D Tax Credits
By Adam Korenfield
Construction is not an industry that has historically been known for innovation, but times are changing. The advent of “green” building and new sustainability standards, along with advances in digital technology and connectivity, have created the impetus for innovation in everything from building materials to modeling and engineering techniques.
Within the construction industry, if a company is financing activities to develop or improve energy efficiency, mechanical systems, process design, pilot plants, construction techniques or other products, processes or software, then it’s likely performing activities that qualify for research and development (R&D) tax credits. Equaling as much as 9 percent of qualified spending, the federal R&D credit is available for taxpayers that incur eligible expenses in an attempt to develop or improve their products, processes, software or — more commonly in the construction industry — techniques. Companies claiming R&D credits will benefit from an increase in cash flow and earnings per share, as well as a reduction in effective tax rate.
The Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently extended and modified the R&D credit, making it more accessible to companies of all sizes. Prior to its passing, companies had to wait anxiously each time the credit expired to see if it would be extended, or they were prevented from benefitting from it because of perceived or actual obstacles.
Many companies have benefitted from R&D credits, with the latest IRS statistics indicating that in 2012, 240 construction companies reported credits, with the average credit being just over $100,000 . However, other companies didn’t, as they believed their activities failed to qualify because they weren’t conducting “R&D,” or that their activities had to be unique from their competitors. Others, particularly smaller companies or start-ups, didn’t seek to benefit from R&D credits because they weren’t paying regular income taxes and were unaware that they could take advantage of a tax credit. Happily, the first set of obstacles — misunderstandings that overstate the requirements to qualify for the R&D credit — can be cleared up rather easily, and the second is razed by the PATH Act.
According to BDO’s 2016 Tax Outlook survey, the No. 1 reason tax executives fail to claim R&D tax credits is the assumption that they aren’t engaging in activities that qualify. The truth is, the construction industry participates in a broad range of activities that may be eligible for the credit, such as attempts to develop or improve energy efficiency; “green” or LEED initiatives; design approaches; structural or utility systems; safety or performance; or construction processes, materials or equipment.
Generally, the R&D credit is available to companies that:
1. Attempt to develop or improve the functionality, performance, reliability or quality of a product, process, software, invention, technique or formula;
2. Encounter uncertainty regarding either their capability or methodology to develop or improve the business component or the component’s appropriate design;
3. Engage in a process of evaluating alternatives to eliminate the uncertainty;
4. Fundamentally rely on technological principles such as engineering or the computer, physical or biological sciences.
Benefits for Small Businesses
Prior to the PATH Act, the R&D credit generally could offset only regular income tax liability. For taxable years starting after Dec. 31, 2015, eligible small businesses (ESBs) can now utilize the credit to offset Alternative Minimum Tax (AMT). Construction companies and their shareholders may receive cash benefits from R&D credits that were previously not available to them because of AMT obligations. ESBs are defined as privately held corporations, partnerships or sole proprietorships with average gross receipts of less than $50 million for the three preceding taxable years.
Eligibility for Start-Ups
For taxable years beginning after Dec. 31, 2015, Qualified Small Businesses (QSBs) can use the R&D credit to offset up to $250,000 of the FICA portion of their payroll tax. The immediate impact and cash flow resulting from this new opportunity can be a tremendous benefit for construction start-ups, many of which are paving the way for industry innovation with new project management tools and automation developments. QSBs are defined as businesses with less than $5 million in gross receipts for the current year and no gross receipts prior to the five taxable years ending in the taxable year.
A Simplified Method
The two methods of calculating the credit remain the same. Since one method — the regular credit method — can require certain financial information dating back to the 1980s, the amount of paperwork and reporting required may have deterred some companies from claiming the credit in the past. The more recently enacted Alternative Simplified Credit (ASC), however, provides a far simpler method. Under the ASC method, only qualified research expenses for the current tax year and the prior three tax years are needed to calculate the credit. And now, certain taxpayers can elect the ASC method on an amended return, something not allowed until recently, giving executives another reason to consider whether they’re leaving benefits unclaimed.
As the construction industry continues to expand its efforts to develop the buildings, infrastructure and construction techniques of the future, construction businesses should consider whether the R&D credit can help them achieve their goals. Different companies will face varied and unique business considerations based on their size and position in the growth cycle, but many — regardless of size — can still reap the benefits from the R&D credit, and be well on their way to cash flow savings.
Adam Korenfield is a tax senior director with BDO USA LLP with experience servicing both public sector and private companies, with a particular emphasis on real estate and construction, medical services and manufacturing businesses. He may be reached at email@example.com or 305-420-8043.