The IRS Is Watching: What Architects, Engineers, and ESCOs Need to Know
The IRS is ramping up its enforcement efforts, and if you’re in the architecture, engineering, or energy services industries, you need to be paying attention. The latest IRS campaign focuses on tax disclosure compliance, whistleblower incentives, and cracking down on taxpayers who aren’t following the rules.
At the same time, businesses are grappling with a major tax change: Section 174 adjustments. Previously, companies could deduct all research and development (R&D) expenses in the same year they were incurred. Now, due to a provision in the Tax Cuts and Jobs Act, R&D costs must be amortized over five years (or 15 years for foreign expenses). This change means many firms—including architecture, engineering, and ESCO companies—are seeing higher taxable income in the short term, leading to increased tax liabilities.
The IRS is also emphasizing the importance of Form 8275 (Disclosure Statement) for businesses taking uncertain tax positions. If you have a tax position that isn’t obvious on your return, you can disclose it to potentially avoid penalties. However, this isn’t a loophole—it’s a way to be transparent about legally defendable positions. Simply ignoring new tax rules or hoping they’ll change later is not a viable strategy.
Whistleblower incentives are also playing a major role in this crackdown. The IRS has paid out millions in rewards to individuals who report tax fraud or non-compliance. This means that if a company is cutting corners, someone within the organization could report it—and get compensated for doing so. The bottom line? Tax transparency is more important than ever.
Section 174 Changes: A Major Hit for Architecture, Engineering, and ESCO Firms
One of the biggest pain points in recent tax changes is the impact of Section 174, which affects how research and development (R&D) expenses are deducted. Many firms invest in developing new sustainable materials, improving energy-efficient designs, and creating proprietary tools for better project execution. Previously, these costs were immediately deductible, reducing taxable income significantly. Now, only a portion of those expenses can be deducted each year, increasing taxable income in the short term.
Some companies have tried to get around this by continuing to deduct R&D costs in full and disclosing that they’ll comply if the rule isn’t changed later. The IRS has explicitly stated that this is not an acceptable disclosure strategy. Firms must comply now, regardless of whether they think the rule might change in the future.
How Can Firms Offset the Impact of Section 174? Enter Section 179D
While the Section 174 changes create a financial challenge, there’s a silver lining: the Section 179D tax deduction. This incentive rewards firms that design energy-efficient commercial buildings, and it can be a powerful tool to help offset the tax impact of the new R&D amortization rules.
What Is Section 179D?
Section 179D provides a tax deduction based on the energy efficiency improvements made to commercial buildings. Architects, engineers, and ESCOs that design energy-efficient systems can claim a deduction of up to $5 per square foot for qualifying projects. The deduction amount varies depending on energy savings and whether the project meets prevailing wage requirements.
Even better, Section 179D isn’t just for private-sector projects. Government and tax-exempt entities can allocate the deduction to the designers responsible for the energy efficiency improvements. That means if your firm designs energy-efficient schools, municipal buildings, hospitals, or university facilities, you could be eligible for significant tax savings.
Using 179D to Counteract 174 Adjustments
Since Section 174 changes increase taxable income by reducing upfront R&D deductions, firms should look at Section 179D as a way to balance the scales. Let’s say an engineering firm has an $800,000 increase in taxable income due to the new 174 amortization rule. If that firm also qualifies for a $1,000,000 deduction under 179D, they could completely offset the negative tax impact of 174 and potentially come out ahead.
Action Steps for Architecture, Engineering, and ESCO Firms
- Stay Compliant with IRS Disclosure Requirements – If your firm is taking any aggressive tax positions, make sure you’re using proper disclosure forms. However, don’t assume that disclosure alone will protect you—the position itself must be legally defensible.
- Ensure Section 174 Compliance – If your firm has R&D expenses, make sure you’re properly amortizing them over five years (or 15 years for foreign expenses). The IRS is closely watching for non-compliance.
- Maximize Section 179D Benefits – If your firm designs energy-efficient buildings, take full advantage of the 179D deduction. If you work on government or non-profit projects, make sure to request the allocation of the deduction to your firm.
- Coordinate with Tax Advisors – With these changes, strategic tax planning is more critical than ever. Work with a tax professional who understands both Section 174 amortization rules and 179D deductions to develop a strategy that minimizes your tax burden.
Conclusion
The IRS’s increased enforcement efforts mean that compliance and transparency are non-negotiable. Firms in the architecture, engineering, and energy services industries must navigate the challenges of Section 174, but they can strategically leverage Section 179D to help offset the tax impact. By staying compliant, maximizing deductions, and working with knowledgeable tax professionals, firms can protect their bottom line while continuing to innovate and design energy-efficient buildings.
Now is the time to take action—because when it comes to tax compliance and planning, the IRS isn’t waiting, and neither should you.
