If you are a specialty contractor responsible for functions such as plumbing, HVAC, electric or sheet metal work, or if you are a contractor that performs value engineering, you may be able to take advantage of some often-overlooked tax incentives.
First things first—what is the difference between a tax credit and a tax deduction?
While a deduction reduces taxable income, a tax credit is a dollar for dollar savings in tax dollars. For example, a $50,000 deduction saves roughly $15,000 in federal income tax while a $50,000 credit reduces taxes by $50,000!
The Research and Development (R&D) credit is a wage-based credit for a new or improved business component whereby you create or improve a process or product. For contractors, processes are the biggest component of what can be used for this credit.
The R&D credit is the most overlooked credit because the name “Research and Development” makes most contractors see it as only having to be scientific in nature. That is false. Research and development does not consist of people in lab coats creating formulas.
What qualifies as a component of the R&D credit?
- Formula, or invention
- The component must be technological in nature
- Elimination of uncertainty
- Process of experimentation
Examples of Qualifying Activity in the construction Industry:
- Work on changing building structure to enhance construction performance, building performance, building reliability or quality
- Develop new technique or construction method to perform construction more efficiently and or better
- Research new methods of construction due to site conditions or unexpected situations
- Create new tool or part
To help determine if you have the right pieces to qualify, it is helpful to run this four-part test:
- Test 1: Permitted Purpose: Have you improved upon any of the following?
- Test 2: Is it Technological in nature (Implementation of technology, engineers on staff)?
- Test 3: Is there a level of uncertainty? (You are implementing something new to see if it will work):
- The R&D reduces any uncertainty
- Test 4: Experimentation-Trying it out to see if it will work. Does not have to be a success.
The PATH Act of 2016 made the R&D credit a permanent incentive. Contractors with under $50,000,000 of Average Annual Gross Receipts can offset their AMT Tax.
- This change is very significant because it became a much bigger benefit for some taxpayers who live in high-income tax states
- Startup companies with little tax may be able to offset payroll tax with the credit