By Stephen Stringer, CPA, Director at Blue & Co., and David Seibel, Senior Manager at McGuire Sponsel
Manufacturing and machine tool clients often qualify for Research and Development (R&D) Tax Credits through internal optimization or new product development for customers.
Contract manufacturers and machine tool companies are often approached by other companies and asked to produce a component, part, or product. They provide feedback to their customer regarding the design, which is used to optimize the part designed and simplify the manufacturing process, known as design for manufacture.
Development can also occur internally when a company identifies the need to develop a new process for an existing product. 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.
There are many sectors within the manufacturing industry, including commercial product manufacturers, machine shops, precision manufacturers, and tool and dye shops. Each sector performs unique processes that can qualify them for the R&D Tax Credit.
Commercial Product Manufacturer
The first type of company to explore is the traditional product manufacturer that designs a product, manufactures it, and sells it commercially.
These companies typically have a product development team and a manufacturing process team who work closely together to ensure both product and process are optimized. They can often claim qualified research expenses (QREs) for both the product design and process development.
When it comes to product and process, they are considered separate R&D projects. These companies are often required to document the particular uncertainties and testing conducted for both the product and process to ensure that the four-part test is met for each one.
Machine shops that specialize in manufacturing their clients’ products often have a great opportunity to claim the R&D Credit.
These companies will often claim the process as the business component being developed, as the product design will come directly from their customer. The process design will often require several iterations to perfect, which clearly establishes the technical uncertainty and process of experimentation portions of the four-part test.
Additionally, if the machine shop is asked to fabricate prototypes to ensure that they can complete the order, this can lead to an opportunity to claim supplies expenses as well as the wages associated with the process development.
Manufacturers that specialize in precision manufacturing, such as aerospace, gas, or the military, are exceptional candidates for the R&D Credit.
These types of companies undertake great technical challenges associated with the customer’s requirements as well as the material they are working with, including precise strength and tolerance requirements.
Similar to the machine shop, there is often an opportunity to claim supplies. Specialty manufacturers often must test several iterations of the production design in order to accomplish the project requirements. Many times, they consume costly material and tooling in the process before it is ready for commercial production.
Special care should be taken to document the uncertainties in the capability, methodology, and/or appropriate design of the process; the testing that was conducted; the number of trials that were run; and the results of each test.
Tool & Die Shops
Companies that design and produce new or improved tooling or dies for their customers can also take advantage of the R&D Credit.
These companies are given a product design from their customer, and it is up to the tool & die shop to create the appropriate tooling and/or die that will be able to produce the part to the customer’s specifications.
The tool and die shop must account for a variety of variables in their designs, including cycle time, product tolerance requirements, and footprint of the die.
There is a large investment of time that is spent on the design, development, fabrication, and testing of the tool or die that may be eligible to include as QREs.
Blue & Co. has the expertise and experience to help manufacturing and machine tool companies maximize their tax benefits with defensible claims. Our team spends time learning the daily operations of clients as they optimize or develop new products or processes. This allows us to build sustainable yet maximized benefits that withstand the highest levels of IRS scrutiny.
If you have any questions regarding the R&D Tax Credit, please contact your local Blue & Co. advisor for assistance.