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Architectural and Engineering Firms Losing Out On Millions

Architectural and Engineering Firms Losing Out On Millions

April 22, 2021
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Architectural and Engineering Firms Can Use Tax Strategies to Free Up Cash

Architecture and engineering firm CFOs have many responsibilities to their firms and owners — one of which is identifying ways to minimize income taxes and free up cash flow for growth, debt reduction, distribution to owners, and other operational uses.

When working with your external tax and financial advisors, try to identify ways beyond the normal cash management of the firm operational expenses, owner compensation, and bonuses to accelerate the timing of deductions. Using strategies like bonus depreciation, expensing qualified equipment, or cost segregation studies on owned buildings or significant leasehold interests can provide strategic tools for your firm. The goal is to improve the present value of the post-tax cash flow to the firm and its owners.

In conjunction with traditional tax planning, several specialized tax strategies apply to architecture and engineering firms and can provide tax deductions or tax credits. Whether a firm and its owners can utilize these strategies depends on a number of factors, including the type of projects and clients the firm has, the level of unique design processes the firm employs, the type of contracts the firm has with its clients, and whether the firm practices internationally.

In addition to the tax benefits, these strategies encourage energy efficiency, sustainability, improved building performance, and innovative, unique, and functional design. The following is a general overview of some of the opportunities available.

Research and development (R and D) tax credit studies

All across the nation, Architecture and Engineering Firms are consistently missing out on millions of dollars in Federal Tax Incentives! 

How?

Simple. Federal Tax Incentives have been crafted, passed, and signed into law making hundreds of millions of dollars available. For some reason, Architectural and Engineering firms consistently fail to capture the money allocated for them.

Why?

Part of it is the fault of government and their lack of effective naming of the Incentives they pass. The Section 41 Credit is inadequately named the “Research Credit”. This poor title makes it sound like it was created to provide funding for medical laboratories. Fortunately the Incentive is so broad, that almost all U.S. based Manufacturing, Engineering, Software Development, and Fabrication firms qualify for money.

How much is available?

We have found Engineering firms, on average, are able to qualify for approximately 25% of total company payroll, consumed supplies, and contractor costs above a certain threshold that are associated with qualifying activities of research and experimentation on unique design processes or products. For example, a typical firm with a $2,000,000 company payroll will be able to qualify $500,000 of their payroll toward the Section 41 Incentive. The gross benefit of this would be anywhere from $25,000 – $50,000 per year (and firms are allowed to go back three open tax years!).

Qualifying activities include the search for new engineering solutions, prototyping, and testing. This includes systematic trial and error coupled with success or failure testing that works to eliminate uncertainty. “Uncertainty” means the information available to you does not establish the capability or method for developing or improving the product or appropriate design of the product. The research doesn’t have to be unique and new to the world, just unique and new to you.

Recent legislation permits the R & D credit for eligible small businesses to offset the Alternative Minimum Tax (AMT), and for certain qualified small businesses, it may offset payroll taxes.

Why doesn’t the CPA just handle this?

To put it bluntly, they are not qualified. Specialized tax incentives such as this are extremely technical and backed by myriads of case law. CPAs do not have the time nor the knowledge to investigate, determine, procure, and defend specialized tax incentives such as the Section 41.

How should Architectural and Engineering firms determine their qualification?

First off, they should not file another tax return or remit the next quarterly estimated payment until they have consulted a specialist in this area. A true specialist will be able to provide a solid estimate of benefits through a brief phone consultation.

Please do not let the government’s failure to name an incentive properly keep you from capturing your benefits in full. Nearly all Architectural and Engineering firms qualify for Section 41 money. If you would like an estimate of how much you are missing out on, please contact us.

Architectural, Engineering & Construction (AEC) Firms Tax Credits

As outlined above, technical based companies are excellent and often overlooked industries for the R&D Tax Credit.

The top misunderstandings about capturing these tax credits: 

They don't qualify for the credit because they are not "Manufacturing"

Section 41 was not designed exclusively for Manufacturers, although they are our most common client for R&D Tax Credits.  Qualification is based on activities performed by the company.   

In fact, Architectural, Engineering, and Construction (AEC) often qualify at much higher rates than traditional manufacturers. 

Too small to qualify for the R&D Tax Credit

Technical based firms may qualify even if well below the typical million dollar payroll threshold.   The reason for this can be found in the way that the credit is calculated.     The credit is not based on total annual payroll, it's based on total annual payroll multiplied by what percentage of that payroll is a qualified activity for the credit based on the IRS definition of Qualified Activities (outlined above).   

This means that a $400K payroll for a technically based company could yield a higher tax credit than a $2.4M annual payroll of a general manufacturer.  

Programs such as the Section 41 R&D Credit, Cost Segregation, Property Tax Mitigation, Energy EPAct, and others can free up cash to be used for growth and debt reduction, and the savings can then be converted into dividends or distributions. The result provides owners with cash at a significantly lower effective tax rate than compensation. Both can also be retroactively claimed through amended return filings. If you are not a Fortune 100 firm, we are your specialized tax incentive advocate and will vigorously work to ensure all eligible monies are captured. If you own an Architectural, Engineering or Construction (AEC) firm and are paying taxes, it is time to contact us for a free analysis of your available incentives.