Many manufacturers, large and small, often overlook a valuable tax incentive. In fact, there’s even a good chance their businesses are eligible to receive federal research and development tax credits for the things their companies already do every day.
Contrary to popular belief, the federal R&D tax credit isn’t limited to the high-tech, biotech and pharmaceutical sectors. Instead, any manufacturer that designs, develops or improves products, processes, techniques, formulas, inventions or software may be eligible. Today’s R&D tax credit can further apply to a wide variety of manufacturing activities including engineering, quality assurance and information technology.
Therefore, it isn’t just a research credit, it’s also a process improvement credit. For many manufacturers, the daily operations of making new, lighter, stronger, less expensive or more reliable products, or developing more efficient and economical processes are considered qualifying activities. What’s more, most states offer R&D credits in addition to the federal tax credit.
Essentially, if an organization manufactures or fabricates products, there’s a good chance an R&D tax credit is available. Because the landscape surrounding the R&D tax credit is ever changing, however, it has created missed opportunities with activities that were once believed not to qualify.
R&D tax credit at a glance
Since 1981, businesses have been eligible for a federal tax credit, under Internal Revenue Code Section 41, on increases in their qualified research spending. The credit was intended to incentivize U.S. companies to continue and increase spending on R&D within the United States.
Since then, however, there have been several changes in how the credit is calculated and which activities qualify. In 2015, Congress permanently extended the R&D tax credit and expanded its provisions. Revised rules allow more activities to qualify for the credit or affect the amount of credit available to offset tax liability.
Expenditures that qualify for the R&D tax credit include:
• Taxable wages paid to employees for services performed in conducting, immediately supervising or directly supporting qualified research.
• Amounts paid for supplies used in qualifying research.
• Sixty-five percent of the amount paid or incurred by the taxpayer to any person, other than the taxpayer’s employees, for qualified research.
Too small? Not at all.
Don’t believe any of the myths surrounding the R&D tax credit — that it’s only for very large companies with big research departments and impressive patents, that it applies only to involved and intensive long-term product development activities or that it’s only for highly mass-produced products. These are outdated and narrow views of R&D activities.
The truth is that if it’s an altogether new or different activity for a company, it just might qualify, and real benefits are waiting. Among them are the immediate source of cash and the reduction in current-year tax liability, as well as a source of permanent tax savings and a financial statement benefit. Another clear benefit is an increase in cash flow.
Still another big benefit? In addition to current-year tax credits, regulations allow eligible taxpayers to “look back” to all open tax years — typically three years plus the current year — for potential credits that were never claimed.
To benefit from the R&D tax credit, any of the following activities might qualify:
• Design and/or manufacture of products
• Production of parts to customer part prints or specifications
• Custom designing and building of machines for sale or use in operations
• Development of new, improved or more reliable products, processes or formulas
• Design of tools, fixtures, jigs, molds or dies
• Development of or application for patents
• Development of software
Get the credit you deserve
The R&D tax credit clearly can benefit manufacturers, and many of their day-to-day activities may qualify. Because the credit has obviously undergone several fluctuations over the years, companies are advised to consult with a professional to better understand the intricacies and take complete advantage of the opportunity. When fully leveraged, the R&D tax credit can provide substantial benefits both in cash flow and for financial reporting purposes.
Valerie K. Fedie is a partner at Wipfli LLP specializing in R&D tax credit services and consulting. Fedie has extensive experience helping manufacturers maximize the value of the R&D tax credit including opportunities with new product or process improvements. She can be reached at [email protected]