August 28, 2018
By Kevin Harris
Given the significant changes associated with the Tax Cuts and Job Cuts Act of 2017, manufacturers may be wondering how research and development (R&D) tax credits fared in the final bill. The lower corporate tax rates would seem to suggest that the credits would be less valuable because there are lower taxes to offset. While this may be the case for a limited number of taxpayers, for the most part, R&D tax credits actually increase as a result of statutory provisions.
The tax law cuts the corporate tax rate from 35 percent to 21 percent, which in effect increases the R&D credit’s net benefit by more than 21 percent, from its previous amount of 65 percent to the law’s 79 percent. The 21 percent increase in the credit’s net value is due to IRC Section 290C(c), which was enacted to prevent taxpayers from receiving a double benefit for their research-related expenses. It requires taxpayers to reduce their deduction for section 174 allowable expenses by the amount of the research credit, or elect a reduced credit generally equal to the R&D credit minus the R&D credit and the maximum corporate tax rate.
For additional information, on how tax reform impacts the R&D credit, read the BDO summary here.
The Value of R&D Tax Credits
R&D tax credits may represent tens of thousands of dollars for your business. However, many businesses are unaware that they can save significant dollars by applying for credit for qualified R&D activities they already are doing. According to some studies, more than 14,000 companies apply for federal R&D tax credits annually, yet that figure represents less than 33 percent of qualifying companies.
Given the popularity of the R&D tax credit program, many states, including Texas, offer their own incentive programs. Companies engaged in research and development (R&D) activities in the state of Texas can receive reductions in either applicable sales tax or franchise tax with certain qualifications. The R&D tax credit is administered through the Comptroller of Public Accounts.
Qualifying Activities for Manufacturers
Does your manufacturing business resolve technological challenges through the innovative use of products and processes? The R&D tax credit extends beyond basic research to include activities related to process design and development.
Think in terms of new techniques and processes, new project design, software, and the design of any new projects, such as those involving mechanical and electrical systems. Do you use innovative materials to create more energy-efficient products or processes?
Listed are just 10 examples of the types of manufacturing activities and innovation projects most likely to contain qualified research.
- Improving product quality
- Development of second generation or improved products
- Product development using computer-aided design tools
- Tooling and equipment fixture design and development
- Optimizing manufacturing processes
- Designing manufacturing equipment
- Increasing manufacturing capabilities and production capacities
- Designing and developing cost-effective operational processes
- Designing and evaluating process alternatives
- Designing, constructing and testing product prototypes
Meeting the Four-Part Test
R&D tax credit eligibility largely depends on whether the work you are conducting meets the criteria established by the IRS in its four-part test:
1) Elimination of Uncertainty (Section 174 Test): You must demonstrate that you’ve attempted to eliminate uncertainty about the development or improvement of a product or process.
2) Process of Experimentation: You must demonstrate – through modeling, simulation, systematic trial and error or other methods – that you’ve evaluated alternatives for achieving the desired result.
3) Technological in Nature (The Discovering Technological Information Test): The process of experimentation must rely on the hard sciences, such as engineering, physics, chemistry, biology or computer science.
4) Qualified Purpose (The Business Component Test): The research’s purpose must be to create a new or improved product or process, resulting in increased performance, function, reliability or quality.
Goldin Peiser & Peiser can help you determine whether your manufacturing business and activities meet the criteria of the test by conducting a tax credit study. To explore your eligibility for the R&D tax credit, contact the Manufacturing and Distribution Group or Kevin Harris at 214-365-2473.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.