Developing a tax-saving strategy for any architectural or engineering firm can be stressful, but sitting down and planning things out is always worth it. The truth is that a well-thought-out tax strategy can help increase net profits for AEC firms of any size, helping to ensure future company growth.
This article looks at how the section 179D tax deduction and R&D tax credit can help increase an AEC firm’s net profits, and how ABGi can maximize your business’s tax benefits with effective tax saving strategies.
Every business is susceptible to cash flow challenges, and AEC firms are no different. It’s essential to know what to watch out for before it becomes a bigger problem. Below are four of the most common cash flow challenges facing AEC firms.
For any business, increasing profits is the goal. Unexpected challenges can appear as profits decrease which could trigger a negative cash flow cycle for the business. The negative cash flow cycle generally looks like this: Difficulty paying off current debt, plus limited funds to invest in future business growth opportunities. Investing the profits into additional projects for growth is a good idea but cash flow challenges can arise if the money gets tied up in other, sometimes unexpected things.
Having a higher than expected tax bill can cause havoc on a companies net profit. Every business is responsible for paying its share of corporate taxes. But just as important is ensuring businesses know about the tax credits and deductions the government has made available to help them minimize tax liabilities.
The government created tax incentives to encourage business innovation and advancement.
Suppose businesses don’t take advantage of the tax credits and deductions they are eligible to receive. This could become an expensive error that decreases net profits because a business must pay off its tax bill.
Furthermore, when it comes time to file income taxes, companies that make mistakes can pay hefty penalties and interest, sometimes even triggering an audit
Sometimes lean periods can hit a business suddenly, so having a rainy day fund is crucial. For the companies that are left scrambling, it can be difficult to make payments on time, source new materials for upcoming projects, and pay for skilled labor – and this can all cause future business to disappear. This impedes cash flow because without the cash on hand, a company can’t pay off current debts or invest in opportunities for new business.
Outstanding receivables can disrupt business activity and kill steady cash flow, causing employees to chase after unpaid accounts and waste time. If this doesn’t get handled quickly, a business can end up running out of money and stunting the possibility for future growth.
When it comes to a solid tax-saving strategy for AEC firms to increase net profit, the phrase “cash is king” comes to mind. Whether it’s an architecture, engineering, or construction firm, cash flow is the lifeblood that keeps all businesses alive and growing.
The key to increased profits is harnessing the power of tax incentives for architects, engineers, and construction firms. Here are two tax incentives to increase net profits.
The firms that qualify for the 179D deduction are involved in designing, building or renovating energy-efficient systems for government-owned or tax-exempt commercial buildings. The eligibility requirements for the 179D tax deduction for building systems include the interior lighting, HVAC, and the building envelope.
The U.S. Department of Energy requires specific 3D energy modeling software, and an independent state-licensed engineer to visually verify commercial buildings who are claiming this deduction. This process is to officially certify that the energy efficiency of the particular commercial building exactly matches the 3D modeling that was done and therefore, reduces energy consumption compared to the building baseline using ASHRAE building standards (American Society of Heating, Refrigerating, and Air-Conditioning Engineers).
Once certified, the 179D deduction available is up to $5 per square foot to the architecture, engineering, or construction firm; the total energy reduction level determines the final deduction amount.
Remember that for an AEC firm to qualify the commercial building must be owned by an entity that is non-tax paying, like government-owned, REITS, tribal land and other tax-exempt entities, and the transfer of tax benefits must be in writing (via an Allocation Letter) to the AEC firm responsible for the design, build or renovation of the energy-efficient building systems.
The research and development tax credit incentivizes companies that demonstrate business activities around new or improved processes, products and/or formulas. These companies can claim a tax credit on qualifying wages, consumed supplies, and contractor costs. There are a lot of qualified research activities that are approved for this tax credit, download this white paper to see a list.
A key aspect is that the research and development for energy-efficient products and processes don’t have to be brand-new to the industry, just new to the business in question; one of the most common myths about the R&D tax credit is that businesses can only claim the credit that same year, which isn’t true.
Some qualifying examples include:
The tax credit also covers systematic trial and error coupled, regardless of the testing results. For example, when it comes to architectural firms' using sketches to conceptualize possible ideas and crafting designs through detailed drawings can all count towards a company’s eligibility for the R&D tax credit.
The R&D tax credit is an excellent tax strategy for businesses to free up funds quickly, pay off outstanding debts, or invest in company growth; for additional information, go here to read more on the requirements for architecture firms to qualify for the R&D tax credit. To be eligible, architectural firms can develop master plans for their next project, work on establishing new cutting-edge ideas for specific structures, and participate in value engineering studies.
Beginning in 2005, the Energy Policy Act aims to encourage the construction of energy-efficient building systems by providing specialized tax incentives to those responsible for the design process. The 179D deduction saw revisions in 2023, including an increase of up to $5.00 per square foot from $1.88.
Previously in 2022, buildings were required to show a 50% reduction in energy consumption to receive the $1.88 per square foot tax deduction. The requirement now states that buildings demonstrate a 25% reduction in energy usage to receive the much higher $5.00 deduction per square foot and the design, build and renovation project has to be in a prevailing wage state .
For additional decreases in energy usage greater than 25%, there’s an additional $0.10 per square foot that can be added. If a building doesn’t meet the 25% energy usage reduction requirement, it can still receive a partial deduction, which varies per state and per square foot.
With these new revisions now in place, it’s never been easier to take advantage of the available tax incentives like Section 179D.
The 179D deduction permits architecture, engineering, and construction companies to receive a tax deduction if they have participated in the design or build process or had a role in the selection of technical specifications for HVAC, interior lighting or the building envelope.
In order to qualify for the tax deduction, the commercial building must be owned by an entity that is non-tax paying, like government-owned, REITS, tribal land and other tax-exempt entities. So, the 179D tax deduction takes the tax benefits and passes them on to the AEC firms that completed the commercial building.
For companies to qualify for a section 179D deduction, they must provide proof that they were involved in making improvements via the design or selection to the building envelope, HVAC systems, and/or interior lighting.
There are some scenarios where a construction contractor might qualify for the 179D deduction if they can demonstrate that their contract required them to add input into the design or selection process. Sometimes, a construction contractor with a “design-build” contract has a much better chance of qualifying than the companies that operate as project managers or general contractors.
The primary objective of the 179D deduction is to incentivize companies to design energy-efficient government-owned buildings. It’s critical to point out that firms that only install, repair, or maintain a property aren’t eligible for this deduction.
Companies looking to claim the 179D deduction can claim it in the same tax year the commercial building becomes operational. Businesses can also claim the deduction retroactively as far back as 2020 using an account method change.
If a building meets the requirements of the 179D deduction study, it can report the deduction on its current-year tax return. Please note, that in order to claim the deduction, a 179D study must be performed by an independent qualified third-party company, like ABGi, using DOE-approved 3D energy modeling software to measure the energy efficiency of the building and improvements.
A state-licensed contractor or professional engineer (PE) will also conduct a physical site visit to officially rubber stamp that the structure matches exactly what was found in the 3D modeling and is exactly as the tax deduction claims it to be. In this process, the third party examines the building’s energy consumption performance and compares it with an ASHRAE reference building to ensure it meets all energy requirements.
AEC companies need a good tax strategy to help increase net profit for their business. Two tax strategies that are a great fit for AEC firms are claiming the 179D tax deduction or the research and development (R&D) tax credit. Incorporating these two tax strategies can reduce tax liability for an AEC business, which helps them accelerate net profit and look good to their shareholders or help them invest in their firm's future projects.
As tax consultants with over 30 years of experience, ABGi is here to help and simplify the complexities that are so common when it comes to specialized tax incentives and tax-saving strategies. As a part of Visiativ, a publicly traded company, ABGi prides itself on upholding the highest compliance standards in the tax industry.
With ABGi, a highly efficient tax strategy to increase net profits is just one click away. If you’re looking to maximize your tax deductions, but require some help developing an efficient tax planning strategy, reach out to us today.