The R&D Tax Credit for Manufacturers – Don’t Scrap the Benefit!

The R&D Tax Credit for Manufacturers – Don’t Scrap the Benefit!

 

The following article is a reprint from an article written on behalf of the Manufacturing Money Newsletter published by Lakeview Consulting, Inc. To learn more about Lakeview Consulting, visit www.lakeviewconsulting.net

By Lacey Robb, R&D Tax Credit Leader, ICS Tax LLC
Email:  laceyr@ics-tax.com
 

While many manufacturing tax breaks have been reduced or have expired, one tax incentive has been in existence for over 30 years and recently made permanent. The Research and Development (R&D) Tax Credit, a dollar-for-dollar tax reduction, has generated over $12 billion dollars annually for companies engaging in research activities. While most Fortune 500 firms claim it, many small to medium-sized manufacturers erroneously believe they do not qualify. In fact, only about 10% of eligible businesses actually take the R&D Tax Credit.Even more surprising, many manufacturers are unaware that some important changes have been made to the R&D Tax Credit that make it more valuable and easier for manufacturers to claim it.

How Is It More Valuable?

  • Lower tax rates in 2018 have increased the value of the R&D Tax Credit by up to 14%.
  • While new rules limit Net Operating Losses (NOL) to offset only 80% taxable income, the R&D Credit can be used to offset taxes on the remaining 20%.
  • The R&D Tax Credit can apply to payroll taxes for startup businesses (i.e., ones in operation less than 5 years).
  • The Alternative Minimum Tax (AMT) is gone for corporations, allowing the R&D Credit to be more accessible for individual owners of flow through business.

What Expenditures Qualify for the R&D Credit?
Eligible expenditures for the R&D Credit are the following:

      1. Wages paid to employees involved in the R&D process;
      2. Supplies used or consumed in the process of research; and
      3. 65% of contract costs paid to others doing research.

In order for the above expenditures to qualify for the R&D Credit, the qualified research must satisfy a four-part test. The following example describes each component of this test.

  • A manufacturer developed a new heat application to its process in order to increase product durability. Its research process met the “elimination of uncertainty” test because the company was uncertain if the heat application could make the product more durable and if it did work, would it be able to maintain the required consistent temperature during manufacturing.
  • The manufacturer’s project passes the “technological in nature” test because it relied upon chemistry, mathematics and physics to determine what heat temperature and settings would be needed, the position to hold the product, and the angle to apply the heat.
  • The research on the new process meets the “permitted purpose” test because it would improve their product strength that they could use in their manufacturing process.
  • For the “process of experimentation” test, the manufacturer conducted a series of tests with different heat settings, different placements and positioning of the product, different angles to apply the heat application and different stages in the manufacturing process to apply the heat treatment. Further, it had to experiment how long to apply the heat treatment and determine whether its equipment could hold the heat consistent.
What Activities May Qualify for the R&D Credit?

      1. Engineering Process and Design
      2. Technical Sales Team Meetings (determining specifications to bring back to engineering team)
      3. Tool & Jig Making for Products
      4. Quality Approval & Control (beyond routine testing and general inspection)
      5. First Time Trial and Article Run
      6. Bid & Quoting Time for New and Redesigned Products
      7. Shipping and Packaging (new package methods to reduce breakage or damage)
      8. Design Meetings (informal or formal brainstorming and tinkering time)

What Are Some Common Misunderstandings in Taking the R&D Credit?

1. We are usually able to sell the prototype for a profit, so it won’t be eligible for the R&D Credit…

Many manufacturers develop prototypes that require new materials and capabilities. These prototypes often have trial runs to resolve underlying technical uncertainties of the product or process development. These expenditures could be eligible for the R&D Tax Credit. Even though the prototype can either be sold or used in manufacturing, the underlying costs could still qualify. As long as there is an engineering-based uncertainty, the ultimate success of the failure, whether it is scrapped, or the sale or use of the product is irrelevant.

2. We haven’t created any new products, all we’ve done is some lean manufacturing or created an ERP system…

Costs to develop new manufacturing processes or improving existing ones can often qualify for the R&D tax credit. Lean manufacturing activities such as evaluating the effect of process improvement on quality of products, reducing costs and environmental impacts; and improving throughput, safety and waste stream disposal. Additionally, ERP implementations are often complex and are rarely simple and routine.

Conclusion
Manufacturers consistently create and improve products and processes, making them eligible for the R&D credit. While not all activities and projects will qualify, the R&D credit is worth considering as it could provide a lucrative benefit.

About the Author: Lacey Robb is the R&D Tax Credit Practice Leader for ICS Tax, LLC. She is an attorney and has an LLM in Taxation and has helped numerous taxpayers in a variety of industries take the R&D tax credit. She can be reached by phone at 310-968-0970 or by email at laceyr@ics-tax.com. To learn more about the R&D credit and other specialized tax planning strategies, visit www.ics-tax.com.

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