Architecture & Engineering Firms 2

Since 1981, companies large and small have been turning to the Research & Development (R&D) credit for tax relief. The credit provides eligible businesses conducting domestic R&D with a dollar-for-dollar offset to their tax liability. Put simply, businesses claiming the credit pay less tax and can even receive cash refunds of prior year payments upon claiming the credit. Successful Architectural and Engineering (A&E) firms often write big checks to Uncle Sam. So why are so many of these firms failing to claim the credit? Often, it’s a simple case of skepticism around whether A&E work is actually eligible for the credit—a credit they often assume is intended to only benefit manufacturers, software developers, and high-tech industries.

In reality, nothing could be further from the truth.

There are absolutely no restrictions to the type of business or industry that can qualify for the R&D credit. Rather, the determination of eligibility is solely defined by IRC § 41, which outlines a “4-Part Test” to determine whether activity is qualified research and development.

With that in mind, let’s look at each these four parts as they relate to the A&E industry:

1. Permitted Purpose Test

This test states that there must be a resultant business component, which is defined as a new product, process, technique, formula, or invention for a project or activity to qualify for the R&D credit. For A&E firms, this business component is commonly the building design itself. That is the product of the firm’s effort to develop a design meeting all of the specifications and requirements presented by the customer within the stated cost parameters. For the participating engineering firms, the design and development of highly functioning and well-integrated structural, mechanical, and electrical systems for unique buildings and structures may also constitute qualified R&D activities.

2. Technical Uncertainty Test

This test requires that at the outset of the project there must be some technical uncertainty around whether and IF the project can be completed, or HOW to complete the project, or the APPROPRIATE DESIGN of the project. Given the highly complex nature of today’s modern structures, rarely is there a design that does not present some technical uncertainty on the way to meeting the requirements and specifications presented by the customer while complying with the ever-changing regulatory environment common to the industry. Not to mention whether or not both of these goals can be accomplished without exceeding the cost parameters of the project.

Think about it, how often do you go into a new project and say, “This is going to be a piece of cake!”

What’s critical to note, is that even if there is no uncertainty as to the capability or method of developing a functional building design, the project will pass this test if the optimal or final design is uncertain at the outset of the project.

3. Process of Experimentation Test

This test states that the firm must engage in an evaluative process capable of identifying and evaluating more than one alternative to achieve the desired result. The A&E industry is particularly well-suited to meet this test and provide the associated documentation to demonstrate the alternatives considered.

From the initial Pre-Design phase to the development multiple iterations of computer-assisted detail design and the ultimate production of construction documents where appropriate, most firms are in a very strong position to demonstrate that they have undertaken a process of experimentation.

4. Technological in Nature Test

This test simply requires that the activities performed rely on the principles of the “technological” sciences. Again, this industry is well-suited to the requirements of this test, since they rely so heavily on the principles of engineering, architecture, and computer science.

As with any tax incentive, exceptions and exclusions with eligibility may come into play. As such, it is highly advisable to seek out an expert in the R&D tax credit area, when considering the credit opportunity.

The Takeaway:

In this era of unique structures, LEED energy performance requirements and designs capable of supporting the high-tech, state-of-the-art capabilities of many of today’s businesses, there is rarely a routine and ordinary A&E project. Rather, engineers are constantly faced with stringent new customer, building or regulatory requirements which lead to new challenges and design alternatives, often resulting in a high-degree of innovative design, engineering and construction. The R&D credit offers an opportunity to offset the cost of resolving these design uncertainties and the testing alternative designs.

To learn more about whether or not your A&E firm is leaving valuable tax savings on the table, contact Tax Credits Group today for a no-cost consultation

About the Author: Michael Krajcer

Michael Krajcer, JD, CPA, is founder and President of TCG. He has spent his entire 35 year career working with the Research and Development Tax Credit. This includes a decade of experience auditing businesses who claimed it, and over 20 years of experience helping U.S. companies navigate through it. He has also resolved dozens of IRS and state audits of credit claims.