In an effort to stimulate more investment in research and development, a valuable Research & Development (R&D) tax credit is available to certain U.S.-based businesses in the manufacturing industry. If your business is involved in any kind of manufacturing and you're not already claiming this credit, you could be missing out.
With a better understanding of what the R&D tax credit entails, who is eligible to claim it and what you need to know before you file your taxes, you can decide whether your business should pursue the R&D credit in the coming years.
Specifically, the R&D tax credit for manufacturing is a federal credit that is offered under Internal Revenue Code Section 41. This credit allows qualifying companies to reduce their dollar-for-dollar tax liability for expenses related to certain research and development costs. In addition to a federal tax credit, many states also offer a tax credit for qualifying research and development expenses.
However, the eligibility criteria required to claim this credit can be complicated, so businesses need to be careful in deciding whether they meet the requirements. In general, a business qualifies for a credit for R&D expenses if the company's work involves:
Some examples of qualifying expenses and activities that could apply to the R&D credit include:
A common question business owners tend to have about claiming R&D credits for manufacturing is whether the credit can be claimed if the business is not yet profitable—as may often be the case for small manufacturing operations and startups.
The good news? Companies with less than $5 million in revenue may still be eligible to claim up to $500,000 in R&D credits, even if the business is not yet profitable.
Many manufacturing businesses stand to benefit from claiming qualifying expenses toward the R&D credit, but it's important to follow some best practices to ensure that your business is claiming only qualifying expenses while reducing its risk for an audit.
For starters, business owners need to make sure that employee time spent on qualifying R&D work is carefully tracked. Because employee compensation for R&D expenses is eligible for this credit, businesses should get into the practice of tracking these hours separately from non-R&D-related activities.
Likewise, businesses will need to keep thorough documentation that demonstrates all experimentation and testing done as part of the R&D process. This, in addition to maintaining records of support documents (such as tooling and prototyping files) is a must for ensuring that criteria are met and being prepared in the event of an audit.
Another important consideration to keep in mind when it comes to claiming R&D credits is that IRC Section 174 has recently been revised—with changes that have made claiming R&D credits somewhat easier for businesses. Rather than being required to spread out certain R&D deductions over a period of several years, businesses can now deduct these expenses in their entirety during the year in which they were incurred.
If your business will be claiming a federal R&D credit for this tax year, it's also a good idea to review your state tax laws to see if you may be eligible for additional credits, deductions or other R&D tax benefits through the state in which your business operates. While not all states offer their own versions of the R&D credit, many (including California, Florida and Texas) do—and the list is growing.
For businesses looking to improve manufacturing processes and products, taking on some R&D expenses is a must. Fortunately, tax credits available through the federal government (and some state governments) make it possible to offset many of these costs in the name of innovation. The key, of course, is to understand the key nuances of this tax credit and to ensure proper documentation before claiming it.
By following these best practices and seeking guidance from a professional if needed, manufacturing business owners can maximize their tax savings while freeing up more funds for further research and growth.
If you have any questions or would like additional information, please contact our Manufacturing and Distribution group.