Michael S. Neubauer, CPA, CVA, MBA
McGill, Power, Bell & Associates, LLP

Tax and credits concept. Getting refund from the income tax return. Calculator, glasses and black pen on financial documents in the background.What comes to mind when you hear the terms “research and experimentation” or “research and development”? If you tend to think of ground-breaking innovations or inventions, you are not alone. For this reason, a number of manufacturers have overlooked the Credit for Increasing Research Activities, commonly referred to as the “R&E Tax Credit.” Many companies don’t realize their efforts, time, and resources could have been used to reduce their tax burden.

Previously, a requirement existed that in order to have activities qualify for the R&E Tax Credit, capability, method, and design all had to be uncertain. Additionally, there was a discovery test which required knowledge exceeding that of other professionals in the field (typically patentable knowledge). This is likely a key factor leading to the present-day misconception that research and experimentation activities must be related to brand new inventions.

In recent years, this requirement was modified so that only one R&E Tax Credits of these items (capability, method, or design) is required to be uncertain, and the discovery test was eliminated. In the case of most custom manufacturers, the capability to do the job and the method by which the job will be completed are certain. However, if design at the onset differs from design at the completion of the job, the design would be considered uncertain and the expenditures incurred would likely qualify for the R&E Tax Credit. A company that has design uncertainty and goes through a process of experimentation in order to eliminate this uncertainty would qualify for the credit. There are R&E tax credits at both the Federal and Pennsylvania level, each offering benefits that have the potential to make a significant impact to a company’s bottom line. When a company engages in a project or job that qualifies for the R&E Tax Credit, wages, materials / supplies, and outside services used in activities prior to the point of commercial production will qualify for purposes of computing the credit. This includes, but is not limited to, the time and materials related to production costs, as well as testing and modification of custom tools, dies, molds, production construction costs, and payments to suppliers.

Approximately 61% of the R&E Tax Credit dollars claimed are within the manufacturing sector. Manufacturers that are typically eligible to receive significant benefits include, but are not limited to: plastic injection molders, powder metal manufacturers, tool & die, fabricated metal, chemicals, primary metals, aerospace, and other custom manufacturers. A significant number of manufacturers in our region have found that with the proper understanding of the R&E Tax Credit, a substantial benefit exists that lowers their tax burden and helps them to be more competitive in the marketplace. In addition, new regulations were recently issued that allow depreciable property to qualify for the credit, as well as allowing for a simplified version of the credit (the Alternative Simplified Credit) to be claimed on an amended return, significantly expanding the potential impact of the credit in the first year it is claimed. Given these recent changes, now is the perfect time to begin assessing whether or not your company qualifies for R&E Tax Credit benefits.