Confusion and gray area have surrounded the research and development (R&D) tax credit (technically called Research and Experimentation tax credit IRS Code Section 41) for years. Both CPAs and business owners struggle to understand the complex nature of the credit, and the definition of “qualified research activity.” But a recent win in the U.S. Tax Court is one giant step in clearly defining this valuable credit for architects in a more robust way.
Congress originally passed the R&D tax credit for research and development in 1981, while consistently implementing expansion and clarifying guidance to the original bill. R&D credits were made permanent in the PATH Act passed in December 2015, along with a provision for start-up companies to offset FICA payroll taxes and qualifying small businesses to offset their AMT (alternate minimum tax) limitations.
The biggest impact for architects was the adoption of the four-part test in place of the Discovery Test in 2004, which changed the qualifying activity from a requirement of “new to the industry,” to “new to the company.”
This designation opened the door for architects to apply the four-part test to their projects in determining the time involved on innovative projects and overcoming technical challenges. The four-part test is defined as: a permitted purpose, technological in nature (engineering), the elimination of uncertainty, and a process of experimentation.
The technical nature of R&D tax credits causes most CPAs and businesses to seek subject matter experts to assist with a formal analysis of qualified activity, time, and complex calculations. At Engineered Tax Services, these experts are tax attorneys who have years of experience and education in the field.
However, IRS auditors are not always as educated or knowledgeable in the specific code requirements or interpretations, which has caused differing opinions between the IRS and taxpayers. Some of these arguments revolve around the term “funded research,” and the assumption of risk rule, which involves contractual agreements between architects and their clients.
What is Funded Research?
The tax code specifically outlines a definition to determine which party to a contract is entitled to the credit: “qualified research does not include “funded research,” as defined as “Any research to the extent funded by any grant, contract, or otherwise by another person (or governmental entity).” No credit is allowable to the contractor for funded research. IRS Sec 41(d)(4)(H).
Research is considered funded research unless two conditions are met: (1) payment is contingent on the success of the research, and (2) the contractor retains substantial rights in the research. (Sec 1.41-4A(d), Income Tax Regs.)
This leads taxpayers and IRS auditors to the contracts between an architect and their client to determine eligibility. In a few cases, the IRS has taken the position that architects are performing funded research. However, the February 2020 court case Populous Holdings, Inc. v. Commissioner of Internal Revenue upheld the Petitioner’s position that in a fixed fee or fixed price contract, it is considered unfunded research, and therefore the architect qualifies for the tax credit!
What this means is that architects now have a solid case to uphold their position in support of R&D tax credit claims. The court docket says that fixed-price contracts are inherently risky to the designer if the research or design is unsuccessful. And under fixed-fee pricing, the designer would have to fix any failed concepts at their own expense, thereby placing economic risk on the designer rather than the client.
The second point of contention with the IRS is the determination of who owns the rights or knowledge to the research. Because many clients gain ownership of the blueprints and building design, it has been argued that the client owns the rights. Many clients own copyrights on their construction documents, models, renderings, and other work product. And the IRS claimed that the architect did not retain rights and thereby is not entitled to the credit.
However, the court decided that “ownership of documents does not dictate the right to use technology-related research results or mean that the clients had exclusive right to the petitioner’s research” (Populous Holdings, Inc. v. Commissioner of Internal Revenue). There was no provision prohibiting an architect from using related research technology in their business, which therefore makes them eligible to their original R&D tax credit claim.
Engineered Tax Services has invested years on Capitol Hill speaking with legislators and the Oversight Committee to discuss the need for clarity from the IRS on R&D tax credits for services industries including architects and engineers, but progress has been slow.
This court case offers supporting case law to defend an architect’s right to claim R&D tax credits for their work on innovative and unique projects, and areas that require overcoming technical challenges in their designs!
Claiming R&D tax credits requires a fair amount of documentation required by the IRS. That’s why it’s important to seek professional help from a consultant with a strong expertise in helping architects successfully claim these valuable tax credits. Our R&D experts dig much deeper into the fundamentals of your business activities—incorporating operations, engineering, financial, and tax expertise that results in more credits and meticulous documentation that is necessary to support your activities, costs, and credit. There is a direct correlation between the amount of your defensible credit and the expertise of the advisor performing the tax credit study.
Learn More About R&D Tax Credits for Architects
The R&D tax experts at Engineered Tax Services have helped companies of all sizes across the U.S. identify and qualify these expenditures and receive the tax benefits they have been missing. Our process begins with an R&D Tax Credit Qualification Analysis to make sure your company qualifies for the R&D tax credit.
To learn more about R&D tax credits for architects, please complete the form on this page. For immediate questions about tax deductions for architects, please contact us at (800) 236-6519.