Co-authored by: TJ Sponsel II, Managing Shareholder at McGuire Sponsel and Courtney Venard, Senior Accountant at VonLehman
Thousands of Manufacturers Are Missing Out on Lucrative Credits
Businesses have been claiming the Research & Development (“R&D”) Tax Credit since the 80s, but there continues to be much uncertainty as to which industries and companies truly qualify for this potentially lucrative annual tax benefit.
While businesses in select industries have a difficult time meeting the qualifications, manufacturing and machine tool companies often have great opportunities in meeting and surpassing the qualifying criteria and generating enough federal tax credits to justify the investment of time and related costs.
VonLehman has had tremendous success building Research & Development (R&D) Tax Credits for manufacturing and machine tool companies. We have worked with manufacturing and machine tool companies with annual revenue ranges between $5 to over 100 million – with yearly effective tax credits from $25,000 to over $125,000.
In determining whether manufacturing and machine tool activities qualify for the R&D Tax Credit, the activities must pass all four qualifying criteria:
Qualifying Criteria
- Be related to development or improvement of a product, process, software program or other “business component,”
- Attempt to eliminate uncertainty over whether, and how, the business component can be developed or improved,
- Involve a “process of experimentation,” using techniques such as modeling, simulation or trial and error, and
- Be technological in nature, meaning it relies on engineering, computer science or “hard sciences,” such as biology or chemistry.
Contract manufacturers and machine tool companies are approached by other companies and asked to manufacture a component, part, product, or assembly process. A contract manufacturer generally provides feedback to their customer regarding part design. This feedback is provided to optimize the part design and simplify the manufacturing process, known as design for manufacture (“DM”).
DM enhances the manufacturer’s ability to produce the part accurately and cost efficiently. A DM can also help customers determine the best possible material for a part. DM 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 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
- Raw materials
- Third party costs
Raw materials that are eligible 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. In order 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.
Expanded benefits for start-ups and small businesses
There’s another reason to revisit the R&D credit. Legislation enacted in 2015 expanded the credit’s availability by allowing start-ups to offset R&D credits against up to $250,000 in payroll taxes. Start-ups are generally businesses in operation for less than five years with less than $5 million in gross receipts.
The legislation also allows small businesses (those with average gross receipts of no more than $50 million) to use the credit to reduce their alternative minimum tax (AMT) liability. Note that 2017’s Tax Cuts and Jobs Act eliminated corporate AMT, but owners of pass-through entities may still benefit from the change.
Worth another look
If your company hasn’t been claiming R&D credits, it’s time to revisit the potential benefits. If available, the credit can boost your cash flow by reducing your tax liability. You may even have the opportunity to claim credits you missed over the last few years by filing amended returns.
VonLehman has the expertise and experience to help manufacturing and machine tool companies maximize their tax benefits with defensible claims. If you believe you may be eligible to claim the R&D Credit, contact our experts today at info@vlcpa.com or 800.887.0437.
