Many owners, officers, and CPAs of architecture and engineering (A&E) firms are unaware that they are eligible for valuable federal and state Research & Development (R&D) Tax Credits. However, due to the expansive definition of R&D for tax credit purposes, many of the day-to-day design and engineering activities performed by A&E firms often qualify for such treatment. A&E activities that can potentially qualify as R&D include:
|Design & Analysis
· Feasibility Studies
· Master planning
· SD, DD, & CD Development
· CAD & BIM Modeling
· Diagnostics Engineering
· Building/Landscape Architecture
· Mechanical, Electrical, Plumbing
· Civil & Environmental
· Other Specialty Engineering
Work Performed Under Contract Can Qualify, and Often Does!
“Funded” research is excluded from the definition of R&D. At first glance, many A&E firms think that because they do work for a fee, that they are “funded.” However, since “funded” research has a narrowly-tailored definition, this is not necessarily true. Each project and contract requires case-by-case funding analysis. R&D performed for a client under a contract is NOT considered funded if both of these statements are true:
1. RIGHTS: The taxpayer retains substantial rights in the research. Rights need not be exclusive (a right to use the results of research in the taxpayer / contractor’s business is sufficient). Lockheed Martin Corp. v. United States, 210 F.3d 1366, 1375 (Fed. Cir. 2000). If not expressly stated, there are typically implied rights.
It is very typical for clients to retain ownership of construction documents and studies created under contract. However, the client typically only has the right to use such documents solely in connection with the specific projects for which the documents were created. Unless explicitly stated otherwise, the A&E firm retains the rights to the research developed in the evaluation, testing, planning, design, and construction process under such contracts.
2. ECONOMIC RISK: The amounts payable under the agreement are contingent on the success of the research. Taxpayer must bear the expense even if research is unsuccessful. The Geosyntec Consultants, Inc. v United States court case (Geosyntec Consultants, Inc. v. US, 9:12-cv-80334 (S.D. Fla. 4/15/13) provides guidance on determining whether R&D expenses relate to activities “funded” by clients. Some key contract provisions affecting risk of loss:
- Final & provisional acceptance of work
- Payment terms
Fairchild Industries Inc. v. United States is another important court case that sheds light on work performed under contract and, specifically, whether a taxpayer bears the economic risk under contract (See Fairchild Indus., Inc. v. United States, 71 F.3d 868 (Fed. Cir. 1995), modified (Feb. 23, 1996)). Fairchild was a contractor working under a fixed-price incentive contract with the Air Force. The Air Force was obligated to pay the taxpayer for its research only if the taxpayer produced results that met the Air Force’s detailed contract specifications. If the taxpayer’s work was unacceptable, the Air Force could reject the work, require the taxpayer to correct the work at its own expense or accept the work at a reduced price. The court ultimately sided with the contractor and stated that the determination of whether a taxpayer is at risk “turns on who bears the research costs upon failure.”
Contracts: Substance Over Form
Contracts are used to determine ownership rights and financial risks, and are usually requested as documentation during IRS examinations. There are many types of A&E contracts for engineering and architecture, subconsultants, joint ventures, construction, design/build, etc. There are also many payment terms and conditions within contracts.
Payment terms generally considered for evaluation of R&D include:
- Stipulated Price
- Fixed-Fee/Lump Sum
- Unit Price
- Percentage of Construction Costs
Payment terms generally excluded from R&D analysis include:
- Engineering capped contracts, which Geosyntec discusses.
- Time & Materials (“T&M”) (Rate Schedules)
Payment terms that are generally not as clear as to their qualification, which is truly determined on the terms of the individual contracts include:
- Guaranteed Maximum Price (GMP) – for example, the AIA A102 Guaranteed Maximum Price (GMP) contract is a fixed-fee contract, and change orders are typically capped. Work under this specific contract would likely not be considered funded.
- T&M Not-to-Exceed
A&E firms should note that certain generally excluded contracts may be partially funded and that they may be eligible to claim credit for qualified costs incurred over the contract capped amount.
Contracts may be called something in form, but are something else in substance. It’s important to look at the contracts and terms. Many A&E firms that consider themselves “T&M” firms, may be doing so based on billing practices and pricing. It is not uncommon to find fixed-fee contracts at firms where pricing and billing is based on T&M, then fixed. BRAYN typically requests representative contracts during the free Phase 1 assessment in order to provide more accurate estimates.
Take Action and Claim Your Benefit
A&E firms are performing activities every day that qualify for the R&D tax credit. Since a majority of their work is performed under contract, careful consideration of contract terms should be evaluated when claiming R&D tax credits. BRAYN Consulting has tax experts with years of experience in the design and construction industry to help you evaluate your R&D tax credit benefit and support your claim.
Further, BRAYNiacs are experienced at harnessing data from A&D software systems like Deltek Vision and Deltek Ajera to aid in detailing and documenting qualifying projects and time.