The R&D Tax Credit was created in the early 1980s to drive business growth and job generation in the United States. But decades later, the full benefit of the credit is often overlooked by manufacturers, particularly when it comes to improving processes and equipment.
According to tax analyst Sara West of SJWest Consulting, manufacturers are often surprised to learn of the extent of the activities covered by the credit.
“Certain qualified activities are often overlooked because those activities are what many consider just a normal part of doing business,” said tax analyst Sara West.
With West’s help, let’s look at why many manufacturers may be leaving money on the table, and how you can avoid doing the same.
What is the R&D Tax Credit?
The Credit for Increasing Research Activities (R&D Tax Credit) was created in 1981 by Congress to reward research activities that result in new or improved products, equipment, processes, and technologies.
“The R&D credit essentially rewards businesses for taking risks to either improve products, machines, or processes, or to create new ones,” West said. “It‘s a monetary reward for trying to do something better.”
“Doing something better” is the basis of continuous improvement. If you’re a successful manufacturer, it’s most likely baked into your operation.
SARA WEST, SJWest Consulting
“When you talk to manufacturers about some of these activities, most think ‘that can’t possibly be R&D.’ They are so used to simply doing these things every day that they don’t realize their activities can be characterized as innovative.”
The key to claiming the credit is to identify the activities that led to the improvement or attempted improvement.
West added, “Success is not a prerequisite to claiming the credit. In fact, when companies try to improve or create something, but ultimately fail, that activity tends to satisfy the definition of R&D as well as, if not more than, successful projects.”
Does purchasing converting machinery qualify for the credit?
In this post, we’re going to focus on how the R&D Tax Credit pertains to the purchase or modification of converting equipment. We’re sorry to say the reward for trying to do something better doesn’t apply to a straight-up purchase of new machinery.
Take the Delta ModTech Crusader® as an example. Long ago, Delta ModTech invested in the machine’s development, knowing its servo-motor approach could improve converting performance. It did all the research and development, and shouldered all the risk.
Yes, if you purchased a Crusader, you would be making your company better. But since Delta absorbed the risk, you wouldn’t qualify for the credit.
SARA WEST, SJWest Consulting
“If your company (not Delta) improves or attempts to improve on the process and the performance of a machine, that’s a different story.”
Altering your process to enhance the performance of the machine or to create a new part may qualify. For example, you may decide to test a new material to convert the same part, and there will likely be some uncertainty in the outcome.
“You can’t just slap on a new material and expect to behave in the same way throughout the conversion process,” West said.
There’s risk taken on your part, so the steps you take to improve performance with that new material could qualify as well.
Start by determining if claiming the credit makes sense
With the broad scope of the credit, defining what qualifies will always be fact-specific and require in-depth legal analysis.
“I’d recommend you talk to an expert, because defining what qualifies and what doesn’t can be a grey area,” West said. “And you don’t want to leave any dollars on the table.”
When West consults with a potential client, she’ll gather a high-level overview of the company structure, how the company operates, and ask questions to identify potentially qualified projects and activities. Then she’ll review company financials and use all of this information to determine a preliminary estimate of the potential tax credit benefit.
This gives the company the chance to make an informed business decision on whether or not it’s worth the time to pursue the credit.
The process moving forward
If pursuing the credit makes sense, West conducts an in-depth analysis. She begins a project list and conducts detailed interviews with people involved with the R&D.
At first glance, the interviews and meetings required for this fact-finding process may seem like a lot. But West explains the initial time commitment is bigger because the mechanics of the credit calculation require some historical analysis. This doesn’t usually need to be repeated in subsequent years, but it is a vital part of an accurate credit calculation.
Plus, smaller projects tend to take less time to cover during the interview process. Finally, West notes that when you work with the same provider, the process should become easier and more streamlined.
The bottom line: How much is this worth to you?
The R&D Tax Credit shouldn’t be factored into the purchase price. It’s tempting to think about the credit in terms of total cost of ownership, but it’s a calculation that can only be made post-purchase, because it is determined by what you do with a machine after acceptance.
It’s better to think of the credit as a financial tool you’ll use every time your company undertakes an initiative to get better. And if you’re a converting company, that type of activity likely occurs on a regular basis.
To learn more about the R&D Tax Credit and how it could benefit your company, contact Sara West at SJWest Consulting for a free consultation.