Many construction companies perform qualified research activities and have claimed the research and development credit activities on the corporate and shareholder tax returns.
Construction contractors are becoming increasingly involved during the design phase of construction projects under Design Build, Design Assist, Construction Management, CM/GC, and GMP type arrangements. These type of arrangements, along with some of the traditional hard bid type contracts have included the activities of construction contractors into the R&D tax credit traditionally limited to engineers and physicists. Often, contractors are involved with constructability input, Building Information Modeling for conflict checks, value engineering, energy efficient design, innovative construction methods for accelerating the construction projects.
In 2023, the government successfully argued that a construction company did not conduct qualified research activities during the tax year in question and was not therefore entitled to the $576,756 refund they were paid. In the case, the defendant was a shareholder of a civil construction company. The courts determined the credit claims failed the 4 part test because the alleged research was “funded research”, meaning the contractor was paid for the research that they were being claiming the credit for. Funded research is one of the 8 exclusions to claiming the credit.
R&D tax credit eligibility largely depends on whether the work you are doing meets the criteria established by the IRS in its four-part test:
- Elimination of Uncertainty: You must demonstrate that you’ve attempted to eliminate uncertainty about the development or improvement of a product or process. In other words, something wasn’t changed solely for aesthetic purposes.
- Process of Experimentation: You must demonstrate – through modeling, simulation, systematic trial and error or other methods — that you’ve evaluated alternatives for achieving the desired result.
- Technological in Nature (The Discovering Technological Information Test): The process of experimentation must rely on the hard sciences, such as engineering, physics, chemistry, biology or computer science.
- Qualified Purpose (The Business Component Test): The purpose of the research must be to create a new or improved product or process, resulting in increased performance, function, reliability or quality.
The IRS offers a section devoted to outlining types of initiatives that don’t qualify for the R&D tax credit. Here are eight items that won’t pass a research and development tax credit audit.
- Research After Commercial Production
- Adaptation of Existing Business Components
- Duplication of an Existing Business Component
- Surveys, Studies, Etc.
- Funded Research
- Foreign Research
- Reverse Engineering
- Social Sciences
The results of this 2023 case should be looked at closely in determining what construction projects have qualified research activities and what projects are really funded research before claiming the R&D tax credits for your construction company.