Leaving Money on the Table?May 1, 2017
As many U.S. manufacturers actively look for business opportunities to improve their profitability or their bottom line, one of the most overlooked resources is the ability to use federal and state research and development (R&D) tax credits.
"I am amazed at how many manufacturers do not realize or understand the IRS's definition of R&D tax credits,” says Benjamin Rashleger, president and CEO of WSI Industries, a contract manufacturer, who discovered the benefits and obtained credits for his company. “If you make or improve a product or a process, either for yourself or your customer, you have activities that qualify for the credit. It can substantially reduce your federal and state tax liability."
A good number of manufacturers do not believe they have R&D activities taking place in their facilities. In reality, if you quote jobs, take orders, build tools, produce products and sell them to your customers, you almost certainly conduct R&D activities.
The R&D tax credit is a dollar-for-dollar reduction of your tax liabilities that provides potentially significant sources of unexpected cash for manufacturers of all sizes, including custom manufacturers that have incurred expenses in pursuit of new or improved products or processes.
According to Black Line Group, the regulatory definition of R&D remains much broader than most people realize. For example, labor and supply cost spent prototyping or using your resources and equipment; costs incurred to quote or experiment with different designs and materials; the design/engineering of new parts and or the process to make new parts; designing or developing tools, including dies and fixtures; and activities related to software development—all may generate R&D tax credits.
Manufacturers of all kinds, including those that design and develop their own products, as well as contract manufacturers and job shops, can take advantage of the tax credit. Both the customer and vendor (job shop/contract manufacturer) of an R&D part can take the credit. The customer will have qualified expenditures around the ‘product’ development/improvement activities of the part or component, and the vendor will have qualified expenditures associated with developing the ‘process’ for making the part.
If you are unsure of how to navigate the process, or don’t even know where to start to see if you qualify for the credit, you are not alone.
“I was skeptical when I first learned of the R&D tax credit,” explains Tom Chacon, of MN-based Boring Machine Corp. “My company did not have what I thought were true R&D activities. I was a job shop just making tools and parts for my customers. Since I learned about the tax-credit process, my company has received tens of thousands of dollars every year in credits. It is like free money to reinvest in my business.”
New Legislation Enhances Tax-Credit Benefits
Until 2016, the reality was that many small and midsized manufacturing companies and their CPAs/tax advisors simply felt that it was not viable to pursue the credits due to specific limitations in the tax code.
This situation changed in late-2015 when federal legislation, the PATH (Protecting Americans from Tax Hikes) Act became law. That legislation, in addition to making the federal tax credit permanent for the first time in the credit’s 35-yr. history, significantly enhanced how small and midsized manufacturers (SMMs) can benefit from the research tax credits they generate, utilizing the following significant provisions:
- Eligible SMMs may now claim the credit against the Alternative Minimum Tax (AMT) to offset AMT for tax years beginning after December 31, 2015.
- Some start-up companies may offset payroll taxes with the credit—in tax years beginning after December 31, 2015, certain start-up companies can use the research credit to offset the employer’s payroll-tax (i.e., FICA) liabilities.
How are these changes significant? In years past, a large number of eligible SMMs (especially S Corporations and other flow-through entities) did not pursue the tax credit because the AMT prevented them from using the credits they could generate. In addition, young companies typically didn’t have a need for tax credits because their expenditures were higher than their sales, thus creating operating losses. Both new changes will allow a higher number of companies to immediately monetize the credits they generate.
Tax-Credit Successes Abound
A number of metalforming and fabricating companies have benefitted from the R&D tax credit and recent passage of the PATH Act.
- A precision stamping and manufacturing company earned more than $170,000 in cumulative credits, including more than $48,000 state and $44,000-plus federal tax credits. It sought to design specialty-sized alignment pins using a noncontact machining method (EDM) on a rotating workpiece while maintaining a customer’s surface-finish specifications. The company tried various combinations of EDM parameter testing and finishing methodologies—all of it eligible for credits.
- A stamping and machining contract manufacturer obtained more than $150,000 in cumulative federal tax credits in its efforts at cost-cutting solutions, continuous improvements and creation of diverse products for its customers. The company evaluated options for manufacture and developed process improvements. Specifically, it tested several laser-cutting options to determine which to use in a flexible environment, and redesigned its manufacturing processes to effectively and efficiently implement new laser-cutting technology.
- A tool and die manufacturer earned in excess of $192,000 federal and state tax credits as it designed and built a new carbide tool. The goal: develop a stronger tool that wouldn’t mark the workpiece. To do that, the company evaluated various tool-workpiece connection-point designs, carbide thicknesses, surface finishes, glues and mounting techniques.
- A metalformer sought to design and build an automotive component using dual-phase steel, earning it more than $114,500 in state and federal tax credits. Springback, a tricky issue when stamping dual-phase steel, had to be accommodated in the tool design to keep the part within tolerance. Design, testing and manufacture all contributed to tax-credit success.
Do any of these real-world examples apply to your company? If so, consider pursuing the R&D tax credit—one of the most generous incentives available to help businesses reinvest. MF
See also: Black Line Group