Construction firms, architects, and engineering companies perform qualifying R&D activities every day — designing structural systems, evaluating alternative means and methods, solving site-specific engineering challenges, developing sustainable building approaches, and applying engineering principles to resolve technical uncertainties. The four-part test fits these industries naturally.
But here’s the catch: the construction and A&E industries are also where R&D credit claims face the highest scrutiny and most frequent disallowance. Two 2024 Tax Court cases — Meyer, Borgman & Johnson, Inc. and Phoenix Design Group, Inc. — denied R&D credits to engineering firms not because the work wasn’t innovative, but because of how their contracts were structured (The Tax Adviser, September 2025).
The “funded research” exclusion under IRC §41(d)(4)(H) is the single biggest threat to construction and A&E credits. Get it wrong and you can have a perfect technical case, perfect documentation, and still lose the entire credit. Here’s what construction and engineering firms need to know — and what to do about it.
Key Takeaways
- Construction and A&E firms must navigate the funded research exclusion under IRC §41(d)(4)(H) — the firm must bear financial risk and retain substantial rights for the research to qualify
- Recent Tax Court losses (Meyer Borgman & Johnson, Phoenix Design Group) underscore that contract structure determines credit eligibility as much as the technical work itself
- Design-build firms typically have stronger credit positions than design-bid-build because they assume more performance risk and control more of the technical solution
- The “shrinking back” rule lets you claim the credit on qualifying sub-components even when an entire project doesn’t qualify — but only if you have business component-level documentation
What Construction and Engineering Activities Qualify?
The qualifying activities under IRC §41 cover a broad range of work that construction and A&E firms perform routinely. The key is whether the activity involves technical uncertainty and a process of experimentation grounded in engineering principles. Here are the activity categories we see most frequently in this industry:
The Funded Research Trap: Why Contracts Determine Credit Eligibility
This is the most important section of this entire post. Construction and A&E firms perform work under contracts with clients — that’s the nature of the industry. But under IRC §41(d)(4)(H), research that is “funded by any grant, contract, or otherwise by another person (or governmental entity)” doesn’t qualify for the R&D credit.
The IRS regulations under Treas. Reg. §1.41-4A(d) clarify that research is considered funded — and therefore disqualified — unless both of these are true:
For research to NOT be considered funded:
| 1 | Financial risk: Payment to the firm must be contingent on the success of the research. If you get paid regardless of whether the technical effort succeeds, the research is considered funded — and disqualified. |
| 2 | Substantial rights: The firm must retain substantial rights to the research results — including the right to use the resulting technology in future projects without paying the client. |
The financial risk requirement is where most construction and A&E firms run into trouble. Here’s the practical translation:
Fixed-price contracts
Generally favorable for R&D credit eligibility. The firm bears the financial risk — if the technical effort takes longer or costs more than expected, the firm absorbs the loss. This satisfies the financial risk requirement.
Time-and-materials contracts
Generally problematic. The client pays for hours worked regardless of outcome. Without modification, T&M arrangements typically fail the financial risk test and disqualify the underlying research.
The contract structure question we ask first: Before we even discuss what technical work was performed, we look at the contract. If it’s structured as a fixed-price agreement where the firm bears the risk of cost overruns, we move forward. If it’s pure T&M with no performance risk, we have to look at whether the contract has alternative provisions — milestone-based payments, performance guarantees, or warranty obligations — that could establish financial risk despite the hourly billing structure. This is contract-by-contract analysis, not a blanket rule.
What the Recent Court Cases Tell Us
Two 2024 Tax Court decisions — both losses for the taxpayer — are essential reading for any construction or A&E firm considering an R&D credit claim.
What this means for your firm: The IRS is actively challenging A&E credits and winning. But these cases also reveal the playbook — firms that lose tend to have weak contract terms (no financial risk, ceded IP rights), insufficient component-level documentation, or both. Firms that prepare the right contract language and document at the project component level have a defensible position.
Design-Build vs. Design-Bid-Build: Why Delivery Method Matters
The project delivery method significantly affects R&D credit eligibility. Here’s how the most common arrangements stack up:
Design-Build (Strongest Credit Position)
Design-build firms control both the design and construction, typically under fixed-price or guaranteed maximum price contracts. They bear the performance risk and retain substantial control over the technical approach. This delivery method generally produces the strongest R&D credit positions.
EPC and Progressive Design-Build (Strong)
Engineering-procurement-construction and progressive design-build arrangements typically transfer significant performance and cost risk to the firm. Particularly favorable when the firm guarantees performance specifications or systems functionality.
Construction Manager at Risk (Mixed)
CMAR arrangements can support credit eligibility for the portions where the CM bears risk — typically after the GMP is set. Pre-construction services billed on a time basis often don’t qualify, but post-GMP design-assist and value engineering work can.
Design-Bid-Build with T&M Design Fees (Weakest)
Traditional design-bid-build with hourly design fees is the most challenging structure for R&D credit claims. The architect or engineer typically gets paid for hours worked regardless of outcome, making the financial risk requirement difficult to satisfy without specific contract modifications.
The Shrinking Back Rule: Your Safety Net
One of the most important tools for construction and A&E firms is the “shrinking back” rule. If your project as a whole doesn’t meet the four-part test, you can apply the test to progressively smaller subsets of the project — specific systems, components, or technical features — until you find the level at which the test is satisfied.
For example: a hospital project as a whole may not pass the four-part test (much of the work is routine application of established healthcare design principles). But specific components might — a custom seismic isolation system, a specialized HVAC configuration for an oncology suite, an innovative wastewater treatment system. Those components can independently qualify for the credit.
From our practice: The Phoenix Design Group case is a perfect illustration of why shrinking back matters — and why documentation matters even more. The court found the firm couldn’t claim the credit for entire projects because not all activities qualified. But it also noted the firm lacked the detailed records that would let the court “shrink back” to qualifying sub-components. The lesson: even if you only think parts of a project qualify, document at the component level. That documentation is what lets you preserve the credit on the qualifying portions when broader claims fail.
Qualified Research Expenses for Construction and A&E Firms
For firms with qualifying activities, here’s what you can actually claim:
Wages
Architects, engineers (structural, MEP, civil, geotechnical), CAD/BIM technicians, project managers performing technical work, principals supervising design. Including C-suite if they’re directly involved in qualifying technical decisions.
Supplies
Materials used for testing or prototyping (mockups, sample assemblies). Cloud computing costs for BIM, structural analysis, or energy modeling software. Most A&E firms have lower supply expenses than manufacturers, but cloud costs add up.
Contract Research
65% of payments to U.S.-based subconsultants performing qualifying research on your behalf — specialty engineering consultants, third-party testing labs, finite element analysis firms. The subconsultant arrangement must satisfy the same funded research test.
What Doesn’t Qualify in Construction and A&E
Activities that don’t qualify:
| ✕ | Routine construction work — installing systems per established plans, standard concrete placement, routine framing |
| ✕ | Standard construction documents — producing CDs from previously-developed designs without new technical analysis |
| ✕ | Aesthetic design — interior design, finish selection, color and material aesthetics, branding-related design decisions |
| ✕ | Funded research — work where the firm doesn’t bear financial risk or doesn’t retain substantial rights (the most common disqualifier) |
| ✕ | Routine quality control inspection — punch lists, standard inspection of completed work to verify it meets specs |
Construction or A&E Firm? Get a Contract Review.
We’ll evaluate your contract structure, identify qualifying activities, and tell you straight whether you have a defensible R&D credit position. The funded research analysis is the critical first step — and we do it before any technical study.
Frequently Asked Questions
Can a general contractor claim the R&D credit?
Yes, when the GC performs qualifying technical work — particularly in design-build arrangements or when the GC’s preconstruction services include alternative means and methods analysis, value engineering with technical uncertainty, or constructability engineering. Pure construction installation following established methods doesn’t qualify, but engineering-driven decisions can.
Does LEED certification work qualify?
LEED certification activities can qualify when they involve genuine technical engineering — energy modeling iterations, alternative system evaluations, sustainable material testing. However, the certification documentation work itself (filling out LEED submittal forms) doesn’t qualify. Focus on the technical engineering behind the certification, not the administrative work.
What about BIM modeling — does it qualify?
BIM activities can qualify when they involve technical experimentation — clash detection that drives design iteration, computational design exploration, custom workflow development, parametric modeling. Routine BIM production (drafting in Revit) typically doesn’t qualify on its own. The activity has to involve solving technical uncertainty, not just using BIM as a documentation tool.
My firm works on government contracts — can we still claim the credit?
Possibly, but with caution. Government contracts often include specific terms about data rights, IP ownership, and cost reimbursement that can trigger the funded research exclusion. Each contract requires individual analysis — including any FAR clauses, technical data rights provisions, and payment structure. Some federal contracts can support R&D credit claims; others can’t.
How much is the R&D credit typically worth for an A&E firm?
It depends heavily on the firm’s project mix, contract structures, and percentage of qualifying time. A mid-size engineering firm with $5M in qualifying engineering payroll might generate $200,000-$400,000 in annual federal credits, plus additional state credits where applicable. The contract structure and documentation rigor have more impact on credit value than the technical work itself. Read our complete R&D tax credit guide for calculation methodology.
What Should You Do Next?
The R&D credit can be valuable for construction and A&E firms, but it’s also the industry where the IRS has had the most recent success challenging claims. The right approach starts with contract analysis — not technical analysis. If your contract structure doesn’t satisfy the funded research test, no amount of innovative engineering will save the credit.
Schedule a free consultation and we’ll review your contract structures and project mix. We work with construction firms, structural engineers, MEP firms, civil engineers, and architectural practices across California and nationwide. We’ve seen the recent court decisions firsthand and know what makes a defensible credit position.
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Martin Gamez
Founder, Tax Formulations
Martin is a tax credit specialist with over 25 years of experience in federal and state R&D tax credits, cost segregation, and business tax incentives. His background includes tenure at Big Four and Top 10 accounting firms, with clients spanning technology, manufacturing, aerospace, engineering, construction, and life sciences. Read full bio →