The Hidden Cost of Construction Cost Cutting: R&D, Value Engineering, and One Common Missed Opportunity

According to CBIZ’s recent middle-market survey, research and development (R&D), also known as research and experimental (R&E), was the area in which most construction companies were “willing to sacrifice if forced to reduce costs or scale back.”

It’s always reasonable to think ahead and plan for the unforeseen by asking hard questions about resource allocation. However, this response highlights a surprisingly persistent misconception within the construction industry.

In construction, R&D is uniquely essential and contrasts with the more typical understanding of R&D as a function of product development. Most hear R&D and think of drug companies developing new compounds to more effectively treat certain conditions, or tech firms pushing the boundaries to introduce new breakthrough technologies like AI. However, that idea of R&D is turned on its head in the construction industry, where R&D spending is central to profitability and margin protection and often occurs in a project’s early stages.

As a result, construction firms that identify R&D as an expense to cut in lean times may not realize that their R&D expenses won’t be going anywhere. Instead, when these cuts are made, the firms may just be eliminating the ability to claim the available tax credits.

The Basics of R&D

It’s a perennial problem in the construction industry: R&D expenses are not appropriately classified, so related tax credits can’t be claimed. As a result, many businesses leave money on the table. When used to their full potential, R&D tax credits can improve cash flow, incentivize investments, and reduce a company’s tax burden.

Without going into deep detail, here are a few basic facts everyone in construction should know about R&D tax incentives:

• R&D tax credits can provide a dollar-for-dollar reduction of federal and state income tax liability;
• Credits are available in addition to the deduction;
• R&D tax benefits can be calculated based on the simplified method to provide a benefit of 5.5% – 7% of the investment, or under the regular method for a benefit of 7.9% – 10% of the investment;
• Credit opportunities exist in approximately 38 states; and
• R&D tax credits can be claimed retroactively for the past 3 years through amended returns.

R&D By Another Name

Many costs that may qualify as R&D are colloquially referred to within the construction industry as value engineering.

Value engineering encompasses a broad range of efforts relating to the adaptation of material processes and techniques, usually to protect the profitability of projects. The nature of the bidding process means that teams with ambitious value engineering programs not only win more jobs by charging less for their work, but also rely on internal or outsourced expertise to identify novel ways to strengthen margins by doing more for less.

Protecting profit is necessary whether or not the business in question pursues the tax benefits often associated with value engineering efforts. Therefore, it’s safe to assume that the companies open to “sacrificing R&D expenses” won’t be cutting the essential value engineering work that is crucial to profitability. Instead, those cuts may only compromise their ability to recognize and claim available tax benefits.

Where R&D Often Goes Unrecognized

The pre-contract bidding phase often sees firms allocating time to rethink design, or hiring engineers or third parties to model, rework, or review plans, and explore other avenues to a more cost-efficient project. Their goal is to lower the price to make a more competitive bid and improve the chances of winning work.

If your firm is asking questions like “is there a better design,” “can we do this more efficiently,” or “how can we build it for less,” you’re likely engaging in work eligible for R&D tax credits. That’s true at every stage of the construction lifecycle, from fabrication, through installation, and whether the questions pertain to material designs or construction processes.

A non-exhaustive list of qualifying activities includes:

• New material combinations and evaluation of their properties;
• Innovative assembly or construction methods;
• Unique bridge or roadway designs;
• Unique construction or innovation techniques in untested environments;
• Building designs to support unique structures;
• Design and development of unique energy-efficient buildings and/or features;
• Construction manufacturing efficiency;
• Request for proposal/request for quotation technical solutions; and
• Engineering change notice/engineering change request activity.

Claiming Tax Benefits on R&D Work

As mentioned, R&D efforts eligible for tax credits are often overlooked. Businesses that are often challenged to improve systems for mechanical processes, fabrication, and installation are excellent candidates for an evaluation of their R&D eligibility.

Analyzing a company’s R&D eligibility typically takes about four working days. Talking through the business and understanding how it works is the first step. Then, if it sounds like R&D might be underway, an advisor will ask the business to produce documentation serving as the basis for a formal R&D tax assessment. The result is a study highlighting current credit claims that may also apply in the future, so long as the nature of the work doesn’t significantly change.

In addition, advisors can design processes to guide and improve R&D expense tracking. With improved practices in place, future engagements can be better managed by the company, unlock additional opportunities, and be less time-consuming.

If you have any questions about the credits available to your business, contact a CBIZ professional today.