The federal tax credit for increasing research and development activities — popularly known as the R&D credit — can be a valuable break for manufacturers. Eligible companies can reduce their tax liability by as much as 7.9 cents (or more if state research credits are available) for each dollar of qualified research expenditures on wages, supplies, consulting fees and contract research. Unfortunately, many manufacturers lose out because they underestimate their R&D expenditures or believe their taxable income is too low to make it worthwhile.
Not just for scientific research
Many people associate R&D with biotech and pharmaceutical companies, but the credit is available to many types of businesses. Generally, qualifying research must:
- 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.
Qualified research expenditures don't need to lead to innovations that are new to your industry, but the changes must be new to your company. For manufacturers, this may include:
- Developing new products;
- Redesigning products to make them cheaper, cleaner or more durable;
- Redesigning processes to make them more efficient, safer or less wasteful;
- Experimenting with new packaging materials or techniques that reduce costs, avoid waste or minimize environmental impact;
- Developing or improving robotics or other automated technology;
- Optimizing tooling or equipment placement; and
- Developing software or other methods for improving quality control.
These are just a few examples, but they give you an idea of the broad range of eligible activities.
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. And you may be able to claim credits you missed over the last few years by filing amended returns.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
