Intensive research is underway for the development of a vaccine, rapid testing methods, and other new technologies during the COVID-19 global pandemic. At the same time, critical equipment needed by our healthcare providers including PPE (Personal Protective Equipment), ventilators, and test kits are in short supply. Many US manufacturers have answered the call by pivoting their operations to produce products to help in the fight against COVID-19. For example, Ford is working with G.E. to help develop and manufacture a simplified version of a ventilator.
Today’s unprecedented challenges have introduced a whole new world of technological and economic hurdles. As US manufacturers work to address this shortage of critical products, they have to quickly figure out the technology required to successfully produce these items. The development of these product designs and the associated manufacturing processes involve significant expenditures.
Along with these risks come additional opportunities to take advantage of the Research & Experimentation tax credit. This credit, also referred to as the “R&E”, “R&D” or “Research” tax credit incentivizes companies to conduct these activities. The outcome of the projects is not a factor, expenditures can be claimed whether the project is successful or not. There is no application process for the federal credit, once the credit is calculated, a form is included with the corporate tax return. The net benefit of the credit, which is a dollar for dollar reduction of tax, is approximately 8% of the qualified expenditures as described below.
Eligible Expenditure Categories
- The time spent on qualified activities can be claimed for the credit. This is related to the wages of the employees that can be engaged in, supervising, or supporting qualified activities. In manufacturing companies, these often include process engineers and design engineers, as well as quality, maintenance, and in some cases production personnel.
- Supply costs include materials and tooling used in the production of samples or trial runs, prototype tooling and in some cases, production tooling sold to customers.
- Activities that if conducted by employees of the taxpayer could be included as qualified research wages, potentially can be counted toward contract research if performed by a third-party contractor. Examples of these costs are outside testing (such as radiography or other NDT, or technical consulting).
Identifying Qualified Projects
Projects must satisfy what is referred to as the “four-part” test to be eligible for the R&E tax credit. Specifically:
- The “business component” test: projects can be for the development or improvement of a product, process, formula, technique, software or invention.
- The “technological information” test: research must fundamentally rely on the physical or biological sciences, or on the engineering disciplines.
- The “uncertainty” test: at the outset of the project there must be uncertainty as to the capability, method (process), or of the appropriate design of the product. In other words, were one or more alternatives considered for the design of the product and/or the process used to produce it?
- The “process of experimentation” test: substantially all of the activities designated as qualified must involve a process of experimentation. Examples of acceptable forms of experimentation include modeling, simulation, or systematic trial and error. In the manufacturing industry, this may include CAD modeling, machining process simulations, and the multiple attempts generally required to come up with a successful design and/or process.
Manufacturing companies are enduring significant challenges regarding their employees, customers, and the current economic climate. Some are realizing benefits from the Cares Act and other programs. The R&E tax credit has been in place for many years, but even for companies that have taken advantage of the credit in the past, new activities brought on by the desire to address the shortage of critical products may provide another source of needed cashflow during these unprecedented times.
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