R&E credit opportunities for the construction industry.

• Author: Gamez, Martin

Taxpayers in the construction industry looking to minimize their overall tax liability or increase cash flow may want to consider one of the largest business tax incentives available to taxpayers--the Sec. 41 research and experimentation (R&E) credit. However, many taxpayers assume that the R&E credit applies only to high-technology, aerospace, and pharmaceutical industries. In reality, the benefits can apply to many other industries, including construction.

In many instances, activities conducted by construction contractors through their engineering and architectural employees are overlooked as R&E activities. When these employees develop and design new and innovative construction techniques, their activities most likely qualify for the R&E credit. This tax incentive may be available if the activities meet the IRS's definition of R&E and are supported by contemporaneous documentation.

Overview of the Credit

The R&E credit was introduced in the Economic Recovery Tax Act of 1981, P.L. 97-34. It is designed to reward U.S. companies for increasing spending on research and development. It is also intended to help companies be more competitive with those of other nations in research and development and to be at the forefront of technological advancement. Congress has not made the credit permanent, renewing it 14 times. Its most recent renewal expired on Dec. 31, 2011. There have been numerous discussions about renewing the credit, but it has not been extended as of this writing.

The R&E credit is available to taxpayers who incur incremental expenses for qualified research activities (QRAs) conducted within the United States. Four types of qualified research expenses (QREs) are the catalyst of the credit:

1. Wages paid to employees for qualified services;

2. Supplies used and consumed in the R&E process;

3. Contract research expenses (when someone other than an employee of the taxpayer performs a QRA on behalf of the taxpayer, regardless of the success of the research); and

4. Basic research payments made to qualified educational institutions and various scientific research organizations.

   R&E Credit Criteria for Construction Projects

   For an activity to qualify for the research credit (i.e., it is a QRA), the taxpayer must show that it meets the following four tests:

1. Sec. 174 test;

2. Business-component test;

3. Process-of-experimentation test; and

4. Technological-in-nature test.

   Once it is established that the QRAs qualify, a thorough analysis must...