By Stephen Stringer, CPA, Director at Blue & Co. & David Seibel, Senior Manager at McGuire Sponsel
Manufacturing companies have claimed the Research & Development (R&D) Tax Credit since the 1980s, but there continues to be much uncertainty as to what and how companies truly qualify for this potentially lucrative annual tax benefit.
While businesses across industries have a difficult time meeting the R&D Tax Credit qualifications, manufacturing and machine tool companies often have great opportunities in meeting and surpassing the qualifying criteria while generating enough federal tax credits to justify the investment of time and related costs to properly claim them.
Over the last decade, Blue & Co. has had great success building Research & Development (R&D) Tax Credits for manufacturing and machine tool companies. Our teams have partnered with manufacturing and machine tool companies with annual revenue ranges between $1 to $125 million – with yearly effective tax credits from $15,000 to $275,000.
R&D Tax Credit Qualifications for Manufacturing
In determining whether a company’s manufacturing and machine tool projects qualify for the R&D Tax Credit, the projects’ activities must pass all four qualifying criteria:
- The research must have goals attributable to a new or improved function, efficiency, capacity, or other performance criteria for a product, process, technique, formula, invention, or computer software.
- The project must fundamentally rely on the hard sciences to discover technological information that does not already exist within the organization.
- There must be a level of technical uncertainty related to the product or process development.
- The technical uncertainty must be tested and eliminated through a process of experimentation.
Contract manufacturers and machine tool companies are generally approached by other companies and asked to manufacture a component, part, product, or assembly process. In addition to developing the process to successfully manufacture the part, a contract manufacturer may provide feedback to their customer regarding part design. This feedback provided optimizes the part design and simplifies the manufacturing process, known as design for manufacture (DFM).
DFM enhances the manufacturer’s ability to produce the part accurately and cost-efficiently. A DFM can also help customers determine the best possible material for a part. DFM activities generally qualify for R&D Tax Credits since they require the analysis and testing of multiple potential solutions.
Development can also occur internally when a company identifies the need to develop a new or improved process for an existing product. There is a level of uncertainty when determining the methodology of a development process. There are many things to consider when conceptualizing a product such as determining cycle time, discovering the optimal sequence of operations, and meeting internal and external tolerances and specifications.
The federal credit is typically five to eight percent of Qualified Research Expenditures (QREs). QREs consist of the following expenses incurred during qualified research:
- Box 1, W-2 wages
- Supplies utilized during development
- Third-party costs
Eligible Supplies for R&D Tax Credit
Eligible supplies for the R&D Tax Credit are tangible materials that are not subject to depreciation and are directly utilized or consumed during the development process. To be considered a supply cost for the R&D Credit, the materials must be used to eliminate technical uncertainty to achieve the final design. This is normally accomplished during the prototyping and testing phases of a project. Material costs can be included even if they are part of a prototype or pilot model that is later sold to a customer, as long as the original intent of the material is to test a hypothesis designed to eliminate the technical uncertainty found in a project. Depending on the specific circumstances of the research, certain extraordinary utility costs may be eligible as well. Any expenses related to leasing equipment costs not directly related to the research, and capitalized equipment cannot be included as supply costs.
Blue & Co. has the expertise and experience to help manufacturing and machine tool companies maximize their tax benefits with defensible claims. If you have any questions regarding the R&D Tax Credit, please contact your local Blue & Co. advisor for assistance.