Manufacturers seeking savings can claim R&D tax credits to save money on their day-to-day activities. R&D tax credits are dollar-for-dollar tax credits the federal government created in 1981 to incentivize companies to innovate.
While research and development are more commonly associated with large corporations with teams of scientists conducting lab work, many manufacturing activities qualify to receive R&D tax credits. However, most R&D tax credits available to qualifying organizations are never claimed because companies don’t think they qualify or are unaware of their existence.
Here are ways your manufacturing business can claim substantial savings on Tax Day.
Ensure all activities pass the four-part test
The IRS issues a four-part test to determine qualifying research activities (QRAs). It is an essential benchmark for manufacturers to consider when including their research and development in R&D tax credit claims.
Qualifying activities must:
- Be technology related: Research and development must involve science disciplines such as computer science, mathematics, physics, biology, or engineering. Social sciences that utilize theories and hypotheses (i.e., sociology and psychology) are not considered QRAs.
- Improve or create new business components: Companies must document R&D activity to verify that they are trying to bring innovation to their business. It is vital to note that research and development discoveries do not have to be groundbreaking or brand new to qualify; QRAs only need to be new to the organization.
- Attempt to resolve technical uncertainty: Businesses must try to eliminate uncertainty surrounding functionality, reliability, or performance. Furthermore, it is crucial to document each stage of uncertainty to substantiate your R&D claim. If you cannot verify your R&D activity, the IRS will likely deny your claim and subject your business to an audit.
- Utilize an experimental process: Manufacturers must demonstrate that they are experimenting with new methods to achieve the desired result. Organizations must detail their testing efforts, including discussions, models, designs, and simulations.
After verifying that all activities meet the criteria for the four-part test, companies must complete IRS Form 6765 and submit it with their tax return to file an R&D tax credit claim.
Designing or improving manufacturing techniques
One of the ways for manufacturers to qualify for R&D tax credits is to design new manufacturing techniques or improve their current ones. Lean manufacturing is a production process that maximizes productivity while minimizing waste. Incorporating lean manufacturing techniques can count as a QRA if a business can verify that they are integrating it into their workflow and making improvements.
Developing prototypes for new machinery
When developing new machinery, R&D teams often develop multiple prototypes before creating the final product. R&D departments can learn from each iteration and continue refining their products before producing the final product. Manufacturers can claim R&D tax credits for production activities expenses, including employee wages and the cost of prototype materials.
Developing new quality assurance processes
Quality assurance is a vital aspect of manufacturing to ensure that products are up to a certain standard of quality and consistency. Manufacturers can improve their quality assurance processes by implementing software that tracks scrap data, the percentage of defective products, and the issues each defective product has. Improving the quality assurance process can save companies money by reducing the costs of disposing of poor-quality items while improving consumer satisfaction.
Improving the manufacturing process using computer-aided design
Computer-aided design (CAD) can help businesses produce more prototypes by enabling R&D teams to quickly make minute improvements and adjustments. Incorporating CAD can benefit manufacturers by allowing them to spend less money on prototype production, have fewer errors, and make refinements with greater precision. Organizations can implement CAD software programs or improve existing ones by ensuring they are up to date.
Replacing equipment with more efficient versions
Manufacturers must constantly keep up with the latest technological developments to remain competitive. Companies can improve their production process by using safer, more reliable machinery. Including new manufacturing equipment can benefit businesses by improving productivity and reducing waste. Another option is to integrate new components into existing equipment, which can be more affordable.
Fortunately, replacing or upgrading manufacturing equipment for more efficient versions can help you qualify for R&D tax credits and reduce the overall cost of the investment.
Incorporating sustainable practices
Some additional QRAs involve incorporating sustainable practices. Reducing manufacturing waste, lowering emissions, and reducing energy consumption are all activities companies can use to substantiate an R&D tax credit claim. In recent years, there has been an increasing demand for sustainability from consumers, which can potentially help your business stay competitive.
Document expenses
In addition to documenting QRAs, companies must track all related research and development expenses, including salaries, contract research expenses, equipment, and supplies. The IRS uses total expenditures to determine how much R&D tax credit you can receive for your company’s efforts.
Companies can receive a percentage of their qualifying research expenses (QREs). In addition, businesses can claim a state-level R&D tax credit along with the federal one if they perform QRAs in a state that provides a tax credit for manufacturing activities.
Manufacturers can save plenty of money by claiming R&D tax credits for their activities. However, claiming tax credits can often be time-consuming and complicated for small businesses. MainStreet finds every R&D tax credit your organization qualifies for, saving you time and money to invest in your company. Contact us to get started today.
