Steven Miller is alliantgroup's national director of tax and the former IRS acting commissioner. Visit alliantgroup.com.
2 key provisions every construction business owner needs to keep in mind
Last December, Congress passed and President Obama signed into law a much-publicized, more than $600 billion tax bill that will have major implications for the construction industry in 2016 and beyond. The Protecting Americans from Tax Hikes (PATH) Act extended a number of crucial tax incentives, many of which are designed specifically for the benefit of United States businesses. There are aspects of this legislation included in the pro-business provisions that are very exciting for the industry.
Specifically, construction executives should pay close attention to modifications to two key provisions: the Research and Development (R&D) Tax Credit and Section 179D (the tax deduction for energy-efficient commercial buildings). The policy changes to these two incentives will provide much-needed stability for construction companies as they file this year's tax returns.
The R&D Tax Credit: The Basics
Before discussing the law's impact on the credit, it is helpful to review how it relates to the construction industry. There are some major misconceptions regarding the R&D Tax Credit's purpose. Those misconceptions often play a large role in leading qualifying construction companies to self-censor away from what can be significant tax benefits. Put simply, despite what the name may imply, the R&D Tax Credit is not just about laboratory research. The credit is also very much about rewarding the applied sciences, or the steps taken to make a product, process or technique cheaper, cleaner, greener, quicker and more efficient. It is the technical problem-solving taking place at a construction site or during pre-site planning that can lead to eligibility and, in the past, work activities that have allowed companies to qualify for the credit.
One general contractor received $438,814 in federal and state R&D tax credits for 2 years' worth of qualifying projects, one of which included renovations made to the existing lobby of a church. During the project, the contractor dealt with several design and construction challenges, specifically with installing the electrical systems in the wall outside the sanctuary. Working with an architect, the contractor evaluated multiple design improvement options and construction methods for installing the electrical systems. This included a constructability analysis related to mounting the electrical systems. The company evaluated alternative means and methods for installing the electrical systems. Ultimately, the company determined placing electrical panels on the steel studs provided the space for feasible routing to run the necessary cables, thereby optimizing the function and performance of the sanctuary's electrical systems. Through the technical problem-solving that is necessary and quite common in the course of a construction project, this general contractor received tax savings that will allow them to reinvest in the future of their business.
Here to Stay
Since its introduction over 3 decades ago, the R&D Tax Credit has been a temporary business credit. Although the credit has been renewed and its reach has been expanded multiple times, the constant (and often deadline-driven) extensions have prevented companies from being able to truly strategize about the future of their businesses around its availability. The PATH Act makes the R&D Tax Credit permanent, meaning from now on, construction business owners can make their future business decisions and investments (be it for R&D or otherwise) knowing full well the credit will be around to help offset the costs.
Opening Up to Small Business
Starting in 2016, small businesses (in this instance, defined as businesses with less than $50 million in gross receipts averaged over a 3-year period) will now be able to claim the R&D Tax Credit against their alternative minimum tax (AMT). Without overburdening the reader with the intricacies of the tax code, the big take home for construction business owners is that the AMT bar was the single, greatest hurdle preventing smaller companies from claiming the R&D Tax Credit. In the past, the AMT bar effectively prevented companies whose activities would have qualified them for the credit from being able to use it to reduce their tax liability.
To increase the access of the credit to more small and midsize businesses, the PATH Act effectively "turns off" the AMT barrier when claiming the R&D Tax Credit. This change is estimated to allow for a hundredfold increase in the number of small businesses that can utilize the credit. This seemingly mundane modification is set to greatly benefit the construction industry, allowing many businesses to hold on to hundreds of thousands of dollars or more in annual tax savings.
In addition to the removal of the AMT barrier, the PATH Act also includes a startup provision that will allow qualified businesses with gross receipts of less than $5 million a year to take the credit, capped at $250,000 against certain payroll taxes, beginning in 2017. The provision was designed with new software and technology companies in mind, but it can apply to construction companies that meet the qualifications as well.
Section 179D Extended
The PATH Act also includes another gift to construction businesses—a 2-year retroactive extension for Section 179D (the tax deduction for energy-efficient commercial buildings). However, the extension includes some important compliance changes that should interest construction business owners. But before getting into the changes, review the basics.
Passed as part of the Energy Policy Act of 2005, Section 179D can provide qualifying construction companies an up to $1.80-per-square-foot tax deduction for every building the company makes energy efficient. The owner of the building can qualify for the deduction, but the key aspect is that a business improving the energy efficiency of a government-owned building at the federal, state and local levels can qualify as well. In this instance, as government entities traditionally do not pay tax and have no use for the deduction, Congress has allowed the government entity to allocate the tax savings to the business responsible for the energy-saving enhancements to the building.
Energy-based improvements eligible for 179D include those made to the HVAC, hot water and interior lighting systems, as well as those to the building envelope (i.e. the skin of the building). In order to claim the deduction, the company must have the energy savings independently certified by a licensed, third-party engineer. To illustrate how valuable the deduction can be, go back to the same general contractor discussed earlier. In addition to qualifying for the R&D Tax Credit, this contractor also qualified for $1.4 million in 179D tax deductions stemming from renovations and retrofits made to several K-12 public schools over a 2-year period. Generally, now common energy conscious changes such as bi-level switching, occupancy sensors for lighting, energy-efficient light bulbs and superior insulation to reduce HVAC usage will qualify for 179D, making the deduction an attractive proposition for any company looking to grow their business.
In the past, all kinds of buildings could qualify for 179D, as long as the energy-saving elements of the building surpass 2001 ASHRAE standards.
However, beginning for buildings placed into service in 2016, the PATH Act raises the baseline to 2007 ASHRAE standards. Bumping up the requirements is a nod to modernizing energy-usage techniques and the need to raise the thresholds accordingly. However, considering that to become LEED v3 certified, one of the prerequisites is that the energy performance of the building must be about 10 percent more efficient than ASHRAE 90.1-2007 energy standards, the thresholds for 179D are still broadly applicable and a practical means to reduce a company's tax liability.
Combined, the PATH Act's modifications to the R&D Tax Credit and Section 179D are set to greatly aid the construction industry. Business owners would be wise to explore their options with regards to these vital business incentives.