Are you taking advantage of the R&D tax credit as an architecture firm?
The IRS provides several different tax credits for businesses. It’s often up to you to sort through them all and know which ones apply to you.
One tax credit that can be difficult for architects is the Research and Development tax credit.
Architects often leave this money on the table – but we don’t have to!
Here’s all you wanted to know about R&D Tax Credits for Architects.
What is the R&D Tax Credit?
The R&D tax credit is an income tax offset created to give American companies a boost. Wages and supply costs used to research new and innovative products or processes can be included in this tax credit -- and save you hundreds of thousands of dollars.
The Research and Development tax credit – also known as the Research and Experimentation Tax Credit – was created in 1981 to foster innovation through funded research and further American technology.
This tax credit started with the Economic Recovery Act. The 80s was a time of economic uncertainty and companies were scared to take risks on the types of architecture and engineering activities this tax credit encourages.
It has been so beneficial for eligible small businesses that it was turned into a permanent part of the federal tax code – after the original act was extended 15 times!
The R&D Tax Credit made it so that businesses that incurred qualified research or experimental expenditures could deduct those expenses within that same taxable year.
While the tax savings is a big reason to go after this, it isn’t the only one. By focusing on the qualifying activities, companies can create new or improved products and designs, and fund research activities.
It really is a win-win for design firms – the qualifying activities can be a major advantage for you, and you get tax credits for them.
However, changes to the tax code have taken effect in 2022.
The Tax Cuts and Jobs Act of 2017 included a provision that, starting on December 31, 2021, all R&D expenses must be capitalized and amortized over 5 years (or 15 years for expenses outside the United States).
The result may be a significant tax liability increase for firms—even firms who do not take advantage of the R&D credit.
Can Architects Claim R&D?
Architects can claim R&D if you are an architecture firm that is less than five years old with annual gross receipts of less than $5 million as an eligible small business.
You can only take the tax credit for up to five years. If this is your first year claiming, you may be able to claim the tax credit for the three years prior.
To help smaller businesses get around some of the barriers to claiming the tax credit, qualified small businesses can now claim the tax credit against their alternative minimum tax (the minimum tax you must pay).
Their gross receipts for three previous tax years need to add up to less than $50 million to qualify to claim against the alternative minimum tax.
In addition to the federal credits, 42 states also provide similar state R&D tax incentives – increasing the tax benefit.
How Does the IRS Calculate this Tax Credit?
The tax credit starts at 20% of your increased costs for the first tax year. Calculating the credit based on how much more you spent on R&D when compared to the previous tax year, encourages you to increase the amount of R&D you do each year.
This income tax offset credit is based on your allowable wage cost or the hours you have spent on qualified research. You can also claim a portion of the expense of supplies consumed during qualified activities. Limitations here include travel, meals, entertainment, phone bills, rent, relocation costs, professional dues, or royalty/license expenses.
In addition to your staff wages and supplies, you can also claim 65% of what you paid for contract research expenses.
All said and done, this is a dollar-for-dollar credit – averaging out to 6.5 percent of all the wages you paid your staff.
How Much Is the R&D Tax Credit?
The maximum credit you can get against your payroll taxes is $250,000. If as a firm you spent around $200,000 on qualified research activities, you could end up with a $13,000 tax credit – reducing your taxes owed.
You can use this cash to hire new employees, increase R&D, and expand or improve your office. Or use this to protect your developing firm from future tax hikes.
Take Advantage of the Research and Development Tax Credit
In 2018, an AIA firm survey revealed 28% of firms applied and received this tax credit.
What’s with the low percentage?
Most architectural and engineering firms don’t realize they are eligible. Phrases like “technological in nature” and “research and development” tend to conjure images of Silicon Valley and phones or computers.
Just in case you still have doubts about your ability to claim these tax credits, let’s take a look at the 2014 case: Trinity Industries, Inc v. the U.S. This case determined that the firm was wrongly denied the R&D tax credit and created precedence for architects claiming this tax credit.
How to Make the R&D Tax Credit Work for You
Disclaimer: we recommend talking to a tax professional to help claim this tax credit.
The hardest part of claiming this tax credit is knowing what is considered qualified research activities. The next section will help you determine eligibility for the tax credit when planning future projects.
The Four-Part Test
According to the AIA, the four criteria for determining if your project contains qualifying activities are:
- An activity that creates a new or improved business component of function, performance, reliability, or quality;
- Technological in nature and related to physical or biological science, engineering, or computer science;
- Intended to discover information to eliminate uncertainty in capability, method, or design;
- An activity that includes a process of experimentation, or evaluating one or more alternatives to achieve a result. This might include modeling, simulation, or systematic trial-and-error.
These criteria aren’t as far out of reach for the architectural industry as you might think.
- Criteria one could include activities that improve energy efficiency like using unique materials in construction for structural energy efficiency.
- Criteria two could include developing a special computational tool for our design process.
- Criteria three could include testing out design features of building systems.
- Criteria four can be met by simulating or modeling alternative design concepts.
Examples of Eligible Work
Here are some of the tax credit eligible activities listed by the tax firm KGBG:
- Achieving Leadership in Energy and Environmental Design (LEED) certification
- Considering and evaluating alternative design concepts
- Designing foundation and earthwork for site conditions
- Developing new or improved designs for structures
- Developing new software applications to use internally to interact with customers/vendors
- Developing preliminary design, development plan
- Developing preliminary computer-aided design (CAD) modeling and testing
- Developing schematic designs
- Developing unique functional and energy-efficient designs
- Use of unique materials in construction for structural or energy efficiency reasons
What Doesn’t Qualify for R&D Tax Credits
Other than activities that don’t apply when using the four-part test, some other limitations to the tax credits include:
- Research that is done after the project is completed. You can’t work on a hospital project and then do research after the fact.
- Any sort of survey or study to improve your internal operations also doesn’t apply.
- There has to be an element of innovation or unique design to the task – you can’t just adapt or duplicate an existing business component.
Recently, the case Populous Holdings, Inc v. Commissioner of Internal Revenue opened up allowing firms to claim this tax credit while working under fixed-price contracts. The case determined that the IRS must determine whether the research was funded with the fixed-price contract or not.
Final Tips on R&D Tax Credits
With this tax credit, it’s important to remember that efforts are rewarded – success isn’t.
If you looked into an alternative material but found that material wasn’t feasible, the effort still qualifies. Surprisingly, a functional design isn’t the point of this tax incentive.
Focusing on the process and not the end result encourages businesses to take more risks.
You can claim portions of a project. If one small component of a building includes qualified activities, you can claim the time spent on that part. The entire process doesn’t need to be groundbreaking.
Whatever you develop through the qualifying activity is your property, not the government's – so don’t worry about losing your work just because you claimed the tax credit. Enjoy the fruits of the new and improved designs you create.
Record Your R&D Activities
Be sure you are documenting all of your projects over the tax year – this will help streamline things when you file your taxes.
If you are still using spreadsheets to track your finances, it’s time for a better method. Our guide to financial health for architecture firms shows you how to manage your firm’s finances more effectively.
With Monograph, you can create a new non-billable project to record all your R&D activities across the firm.
Once you have created the project, you can set the Total Fee for this Research Project as $250,000 (the maximum credit you can get against your payroll taxes.)
Just like a regular design project, you can create phases like Research and Development, and set up a plan with team members and their potential allocated time.
Beyond planning for your research project, you need to staff your team on it. Monograph Resource allows you to update the staffing plan with the planned hours so you don’t have to input your data twice.
Once your research project is started, your team members can track their time directly into the Research Project eliminating your headache of tracking these activities.
When it’s time to file taxes, you can export a report out to your accountant with how much money you have spent on R&D projects to claim your R&D tax credit.
Note: if you have multiple R&D initiatives going on, you can create multiple R&D projects to track them inside Monograph.
Grow Your Business with the R&D Tax Credit
At up to $250,000 a year, the R&D tax credit is a lucrative incentive. Take a look at the work you are already doing and pick out what could qualify.
If you aren’t doing many activities that qualify, it might be time to add some. Not only will you get tax credits to do so, but it benefits you as a firm to be innovative.
Start tracking your R&D activity with Monograph, get started today.