When the federal government created the research and development (R+D) tax credit, the goal was to encourage innovation across all industries, not just scientists working in a lab. Your construction business may qualify for a tax credit simply for the natural experimentation part of your day-to-day operation. By understanding how this credit works, you can find more opportunities to innovate while trimming your tax bill at the same time.
How does the R+D tax credit work?
The R+D tax credit gives companies a tax incentive for spending on innovation. This includes inventing new products, but not exclusively. The IRS also defines research as the development and improvement of processes, techniques, formulas, and software. The credit started as a federal tax benefit, however, more than 30 states have similar versions that offset state-level taxes as well.
How can I use the R+D tax credit for my construction business?
Given the IRS’ broad definition for R+D, a wide range of construction research activities could help your business qualify. This is especially true if your firm takes on engineering, design, and/or design/build work as part of your projects. Some possibilities include:
- Designing new structures, like “green” building designs to improve energy efficiency
- Experimenting with new construction processes or techniques to see if they can save time, energy, or costs
- Evaluating new, novel materials or structural designs in order to complete a project
- Making technique enhancements to tackle a new challenge, like improving piling systems to deal with unique types of geology
- Creating innovative electrical or HVAC systems for buildings
The innovation only needs to be new for your company, not the entire industry. For example, perhaps you develop a new construction process that other firms already use. However, they keep it secret, so you had no way of knowing this information besides doing your own research—this may also count.
The IRS also rewards the investment in R+D, not the final result. So you could still qualify for qualified research spending even if it does not lead to an actual successful breakthrough.
What could this tax credit do for my bottom line?
There is no limit on how much credit benefit you may receive, so the more qualified expenses you incur, the larger your credit. You could save even more money for your construction business’s tax return if you operate in a state that offers its own, additional credit.
Since this is a tax credit, it is a dollar-for-dollar reduction of your tax bill on top of the deductions you already receive for business expenses. Some of the expenses you could potentially claim under this credit include:
- The salaries you are paying employees working on engineering, design, and/or design/build projects
- The cost of raw materials and supplies used during their prototype research
- Payments made to 3rd party contractors for helping with your construction R+D, like engineering contractors or research institutions
If you do not owe enough taxes to use the entire construction R+D tax credit in a year, you can carry it into the future for up to 20 years.
Smaller start-up construction companies may still receive the benefits. For example, if your company has less than $5 million a year in revenue and has had no gross receipts dating back more than five years, you can also use the R+D tax credit to offset your federal payroll taxes.
How does the IRS approve research activities?
Besides the broad view of innovation, the IRS uses a four-part test to decide if spending qualifies for the R+D tax credit. To be eligible, your construction research activities must meet all the following:
- Business component/qualified purpose
You must identify the specific affiliated component of your construction business you are looking to improve with your research. A component could be a product, process, computer software, technique, formula, or invention.
- Elimination of uncertainty
Your research must seek to discover new knowledge as part of innovating. To qualify, you must be unable to learn this information in any other way, as it is not publicly available or does not exist—that is why you had to invest in research.
- Technological information test
The R+D credit only applies for activities that are technological in nature. The IRS says this includes research based on the principles of physical or material sciences, engineering, or computer sciences. Employees do not need to be licensed engineers for their work to qualify. Chances are, your existing construction, design, and engineering research will pass this test. However, non-technological research, like a marketing surveys, artistic works, or aesthetic changes would not qualify.
- Process of experimentation
The final test requires that you find your innovation through a process of experimentation. This could include methodologies like trial and error, computer modeling, or simulations. Essentially, it means trying different approaches to test your hypothesis and find ways to improve your design and engineering techniques.
How can you identify R+D opportunities?
The basis of the R+D credit is that it rewards construction business owners looking for a better way of doing things: better materials, better techniques, better constructions processes, better building designs, etc. If this is how you approach your work, you could naturally be running into R+D opportunities.
Keep the four-part test in mind as you make investment decisions. If spending passes all four tests, there is a good chance it qualifies for the credit. Be sure to flag expenses you think may qualify so you can submit them to your tax advisor for review.
How can you create a process for innovation?
If you are looking for more R+D opportunities, make innovation part of your company culture. Let your employees know that they are welcome to propose and try new approaches. Start with small developments and use the process of experimentation from the four-part test to see what works and what does not.
Explain the fundamentals of this tax credit to your employees as well and how their work may directly impact the company’s bottom line. That way, they can make sure their research proposals meet IRS’ standards.
You could make a passion for innovation part of your firm’s branding in order to stand out from competitors, as well. Let clients know you are regularly looking for ways to improve the construction process. They may have ideas which help their project while simultaneously allowing your company to receive additional tax benefits.
Optimizing Your Business with Aldrich
If you need help figuring out how to qualify for the R+D tax credit, consider bringing in a tax expert experienced with these rules. Together, you can maximize your financial benefits while creating a process for innovation that serves you, your business, and your industry for years to come.
Meet the Author
Tax Credit Director
Alex Bray, JD, LLM, MBA
Aldrich CPAs + Advisors LLP
Alex Bray is a taxation law expert as well as a licensed attorney with a Master of Laws in Taxation and an MBA. Prior to joining Aldrich, Alex was a Tax Senior at a Big Four firm where he specialized in business tax advisory and quantitative services. During his time there, Alex enjoyed connecting with…
- Agribusiness tax credits
- Construction tax credits
- Engineering tax credits
- Manufacturing tax credits