An Update on Research and Development Credits
By PHILLIP ROSS, CPA, CGMA, PARTNER
The availability of the Internal Revenue Section (IRC) Section 41 Research and Development (“R&D”) tax credit for construction companies stems from the recognition by the U.S. government of the crucial role these industries play in advancing technology and innovation within the built environment. The nature of construction projects often involves significant research and development activities aimed at improving design methodologies, construction techniques, and overall project efficiency. These sectors continuously strive to enhance sustainability, safety, and functionality, driving innovation in building materials, methods and technologies.
By making the Research and Development Tax Credit accessible to architects, engineers, and construction companies, the government aims to incentivize investment in creative and forward-thinking solutions, ultimately fostering progress and excellence in the construction and infrastructure development fields. This tax credit serves as a catalyst for these industries to push boundaries, adopt cutting-edge technologies, and contribute to the overall advancement of the built environment.
The Current Interplay Between The Section 41 R&D Credit and Section 174 Research/ Experimental (R&E) Capitalization IRC Sections 41 and 174 both play pivotal roles in shaping the landscape of tax incentives for R&D expenses, yet they differ significantly in their scope and application. Section 41 focuses specifically on the Research and Development Tax Credit, which allows businesses to claim a credit for a percentage of qualified research expenses, including wages, supplies and contract research expenses. Section 174 is more expansive, encompassing a broader range of expenses related to research and experimentation (“R&E”), and applies irrespective of whether the taxpayer has claimed a tax credit.
For tax years beginning after Dec. 31, 2021, the Tax Cuts and Jobs Act (TCJA) eliminated the option to deduct Section 174 R&E expenditures in the year incurred. Whether or not taxpayers claim a tax credit for R&D costs under Section 41, Section 174 now requires taxpayers to capitalize and amortize R&E expenditures over five tax years for U.S. spending and 15 years for foreign expenses.
Current Status – Currently, there are numerous lobbying efforts by industry groups and companies to revert Section 174 rules to the prior version, which allowed for immediate deductibility for R&E expenditures. Some states have decoupled from the capitalization requirements. However, passing federal legislation will require bipartisan cooperation in the House of Representatives, the Senate, and the White House. While the current Section 174 capitalization rules can have a negative impact on cash flow, the overall tax benefits of the R&D tax credit remain the same. The capitalization requirement exists whether or not a tax credit is claimed.
While we can remain hopeful, at the present time, taxpayers should prepare to comply with rules set forth by the IRS in Section 174 in the absence of strong stewardship of the U.S. economy on Capitol Hill.
About the author: Phillip Ross, CPA, CGMA is an Accounting and Audit Partner and Chair of the Construction Industry Group at Anchin, Block & Anchin, LLP. For more construction industry thought leadership and content, log on to www.anchin.com.