With constantly evolving tax regulations, architectural organizations—particularly those operating in numerous jurisdictions—face significant complexities that can drain focus from core business objectives.

Fortunately, taking a proactive approach to tax planning can help address challenges before they become obstacles. Simultaneously, architectural organizations may also be eligible for tax credits and incentives that can help boost cash flow and alleviate operational expenses.

Explore solutions for top concerns that can interfere with an architectural firm’s tax planning strategy, as well as opportunities to pursue tax credits to help your better prepare for next tax season.

Top Tax Planning Considerations

Architectural organizations encounter several tax considerations that can impact their financial strategies. Key areas to explore include:

• Internal Revenue Code (IRC) Section 179D
• International tax
• State and local tax
• Federal tax
• R&D tax credits

IRC Section 179D for Architects

Section 179D, also known as the Energy Efficient Commercial Buildings Deduction, provides architects with an incentive to incorporate energy-efficient features in their commercial building designs.

For tax years 2022 and prior, Section 179D allows architects designing government buildings to claim a tax deduction of up to $1.80 per square foot—inflation adjusted to $1.88 per square foot for 2022—for work performed on interior lighting, building envelope, and HVAC and hot water systems.

The Inflation Reduction Act of 2022 significantly increased the Section 179D deduction, making it particularly beneficial for architects. These changes apply to qualifying property placed in service after December 31, 2022.

Qualifying for Section 179D as an Architect

Architects who create technical specifications for the installation of energy-efficient commercial building property can qualify as designers under the tax code requirements. If these architects work on projects for tax exempt entities, the Section 179D deduction associated with the construction project can be allocated to them.

Claiming the Section 179D Deduction as an Architect

Architects can claim the Section 179D deduction by conducting a Section 179D study in the same tax year as when the building is placed in service. If the building was placed in service in a previous tax year, amended tax returns would be required.

A Section 179D Study

A Section 179D study involves a qualified third-party using Department of Energy-approved energy software to model the energy performance of the building and improvements. The energy model is then compared with a reference building that meets relevant energy efficiency requirements, according to standards set by the American Society of Heating, Refrigerating, and Air-Conditioning Engineers (ASHRAE).

Changes to Section 179D from the Inflation Reduction Act

The Inflation Reduction Act introduced four main changes to Section 179D. These include increased qualification thresholds, a bonus deduction, expanded deduction allocation to tax-exempt entities, and an alternate deduction path.

Section 179D deductions can also help offset the impact of reduced R&D expense deductions, which are now capitalized and spread out over future years.

Potential Tax Law Changes

On January 16, 2024, leaders in the House Committee on Ways and Means and the Senate Committee on Finance released a bipartisan framework summary, the Tax Relief for American Families and Workers Act, which could make taxpayer-friendly changes to the tax strategies outlined above.

It includes the delayed application of the requirement to capitalize and amortize domestic research and experimentation (R&E) expenses until taxable years beginning after December 31, 2025, retroactive to taxpayers beginning after December 31, 2021.

On August 2, 2024, in a 48 to 44 vote, falling below the 60-vote requirement, the US Senate failed to advance the Tax Relief for American Families and Workers Act.

The bill, which was passed by the House earlier this year, contained provisions that would expand the child tax credit, delay the research and experimental expenditures capitalization requirement, extend bonus depreciation, and enhance deductibility of interest expense.

Tax law can change quickly, please reach out to a Moss Adams Professional for the most up to date law related to this subject.

International

For those times where an architect is working on a project outside the United States, this can generate both challenges and opportunities.

Permanent Establishment Considerations

To the extent that services are taking place outside the US, this could create a taxable presence in that country. This will depend on the tax law in that country, as well as any income tax treaty the US may have with that country. It’ll be important to document what’s occurring with regard to the project as well as the amount of time spent outside the US by the firm’s professionals.

In addition to income tax exposure, provision of services may result in the need to register for, collect, and remit value-added tax in the local country. As each country will have its own rules as to when this is applicable, it’ll be important to make sure this is resolved prior to entering into agreements with clients.

IC-DISC

To the extent that a project is outside the US, an architectural firm can consider using an IC-DISC to reduce their overall tax liability on the project. There are procedural and documentation requirements, as well as making sure that the structure is in place prior to beginning work on the international project.

State and Local Tax Planning for Architects

There are over 12,000 state and local taxing jurisdictions that may impose multiple types of taxes. State taxes can have a significant impact on your bottom line, and failing to comply with state tax laws can result in penalties and fines.

How to Plan for Gross Receipts Taxes

Gross receipts taxes are levied on the gross receipts of a business, without deductions for costs or expenses. Unlike sales taxes, which are charged to consumers at the point of sale on specific goods and services, gross receipts taxes apply to all gross receipts attributable to the taxing state.

States that impose gross receipts taxes include Delaware, Nevada, Ohio, Oregon, and Washington. Additionally, some localities, such as San Francisco and certain municipalities in Pennsylvania, also impose gross receipts taxes.

While architects are generally not subject to most transaction-level taxes such as sales taxes, they’re often subject to gross receipts taxes which have a broad base and few exceptions or deductions.

Identifying when an architectural service may be subject to gross receipts taxes in advance of starting to do business in a new state may be helpful because it may factor into the business’s pricing or fee structure established for the project.

Furthermore, gross receipts taxes have different sourcing methods which may look at either where the project is located or where the work is performed. Understanding how the tax is applied and how sales are sourced to any given state may be helpful in tax planning and strategy.

Income Tax Considerations for Sourcing Sales

Income tax sales factor sourcing is used by states to determine how much of a business’s income is subject to state income tax. The sales factor is calculated based on the ratio of sales in a state to total sales, but the rules on how to determine sales in a state can vary. Some states use cost of performance, which sources sales based on the location of direct costs associated with a contract, while others use market sourcing, which sources revenue based on where the customer receives the benefit.

Market sourcing is becoming increasingly common, with many states now using this method to source revenue to the location of the project. However, many architects are still using cost of performance and sourcing all revenue to their physical locations. This approach could lead to exposures in states that use market sourcing and in which the architect has projects.

Nexus Considerations

Nexus is a legal term that refers to a connection between a taxpayer and a state, and it must be established before a state can legally impose tax. Nexus can be established through physical presence, such as having an office location, remote employees, or traveling to job sites. Nexus can also be established through economic presence, which is generated by revenue from job sites in a state, even if there’s no physical presence.

Understanding nexus is an important consideration for architects who have jobs in multiple states. Failure to comply with state tax laws can result in penalties and fines. By taking a proactive approach to nexus, architects can avoid potential exposures and ensure they are following state tax laws. This may include reviewing their business activities in each state, tracking revenue associated with job sites, and understanding the revenue thresholds for economic nexus.

Pass-Through Entity Tax (PTET) Elections

Making a state pass-through entity tax (PTET) election can offer significant benefits for architecture firms. This election allows eligible entities to circumvent the $10,000 cap on state and local tax (SALT) deductions imposed on individuals.

By opting for the PTET election, the entity itself pays the tax, enabling a full federal tax deduction of state taxes at the entity level, potentially leading to significant tax savings. Additionally, the PTET election can offer enhanced flexibility in tax planning through intentional timing of the payments. Caution should be exercised, as some states impose strict requirements in timing and manner of PTET elections, and it’s important to work with tax advisors to meet various eligibility rules.

Consumption Based Services

Sales and use taxes are generally imposed on the sale of tangible personal property and certain services. Generally, the only states that impose sales or use taxes on the sale of architectural services are Hawaii, New Mexico, and South Dakota. For that reason, architects rarely see sales tax applied to their core design services. 

While architectural services are generally not subject to sales taxes, there are a few states that do impose sales tax on most services. Additionally, architects must manage sales and use taxes on purchases of materials, software, and certain subcontracted services.

Understanding the nuances of these taxes is crucial for maintaining compliance and improving project costs. A common issue is that architects are often either overpaying or underpaying sales or use tax on their digital products are used across multiple states.

For these reasons, establishing a process for the company to manage sales and use tax issues on purchases as part of the accounts payable processing can often reduce risk of over- or under-payment.

Identifying potential sales and use tax obligations early in the project planning phase can also help architects avoid unexpected costs and ensure proper tax treatment, aiding in accurate budgeting and financial planning.

Additional Federal Tax Considerations

Factors regarding federal tax for architects are as follows.

The Cash Method of Accounting

The cash method of accounting can be a strategic tool for architecture firms. This method, characterized by its simplicity, recognizes income only when cash is received and expenses only when they are paid. This provides a real-time snapshot of the firm's cash flow.

Furthermore, the cash method can offer a strategic advantage for taxes. It allows firms to defer income associated with the net receivables, potentially reducing the current year's tax liability. Moreover, it provides the flexibility to manage income and expenses strategically.

Expiration of Key Provisions of the Tax Cuts and Jobs Act (TCJA)

The potential expiration of specific provisions of the Tax Cuts and Jobs Act (TCJA) at the end of 2025 could have significant implications for architecture firms. The TCJA, enacted in 2017, introduced lower corporate tax rates, which aren’t scheduled to expire under current law, along with favorable deductions for pass-through entities, among other provisions.

However, with the scheduled sunset of the 20% qualified business income deduction for tax years ending after December 31, 2025, owners of architecture firms structured as passthrough entities could see an increase in their federal income tax liability in 2026. It’s important to maintain a flexible financial strategy that can adapt to potential changes, as possible legislative changes to the TCJA provisions are not expected until sometime in 2025.

R&D Tax Credits for Architects

Both federal and state R&D tax credits offer architects incentives to invest in R&D activities when taking on innovative or green sustainable projects. This can help create long-term tax savings and increase the firm’s cash flow to promote reinvestment and additional growth opportunities.

How Architectural Firms Can Use R&D Tax Credits

Architectural firms can utilize R&D tax credits by claiming eligible activities, such as developing new building materials or techniques or creating innovative design solutions to improve energy efficiency. This can significantly reduce their tax burden and free up capital for further R&D in sustainable or efficient building technologies and solutions.

The definition of R&D activities are wide ranging and can relate to many innovative activities. By claiming these credits, firms can reduce their long-term tax burdens and free up capital to invest in more challenging design projects.

How R&D Tax Credits Can Be Affected on a State Level

State-level policies can significantly impact how R&D tax credits function for businesses. Here's a breakdown of two key influences:

Credit Rates and Eligibility

Each state sets its own credit rate, which is a percentage of qualified R&D expenses that a company can deduct from their state taxes. Additionally, some states may have stricter or looser eligibility requirements compared to the federal guidelines for qualifying activities. This variation can make a big difference in total tax savings.

Stacking with Federal Credits

Companies can often stack state R&D tax credits on top of the federal credit, offering a more substantial tax benefit.

We’re Here to Help

To learn more about solutions for the top tax issues for architects, contact your Moss Adams professional.

Additional Resources

• Tax Credits & Incentive Services