"We’re a manufacturer, not an engineering firm. I’m not sure we really do R&D.” “We’re not a Fortune 500 company; I’m not sure we have enough R&D to file for a credit.” These comments are common from mid-sized manufacturers. When it comes to the Credit for Increasing Research Activities (I.R.C. §41, “the R&D credit”), a common misconception is that a company won’t qualify for the R&D credit if it doesn’t have a laboratory, a dedicated R&D division or an engineer on staff. While those things can certainly be evidence of R&D, they are far from being the only factors.
In reality, manufacturing companies actually benefit from the R&D credit more than any other group. Since 2005, manufacturers have consistently claimed approximately 70% of the total amount of R&D credits given out by the federal government.1 The term “R&D” conjures the idea of laboratories, engineering firms, and other organizations that focus solely on scientific research. However, as Figure 1 shows, “professional, scientific and technical services” companies make up a very small percentage of the credit when compared with manufacturers.2 Manufacturers have consistently claimed around 70% of the R&D tax credits since 2005.
This is due, in part, to the fact that manufacturing companies frequently engage in numerous types of activities that may not seem like traditional R&D but actually do meet the requirements of §41 for purposes of finding qualified research expenses for the R&D credit. As a result, manufacturers frequently have more R&D expenses than they think and are ideal candidates for filing the R&D tax credit.
Part of the misconception regarding who can take the R&D tax credit stems from the definition of R&D. Put simply, §41 includes a four-part test for qualified expenses:
• The activity must be for the design and/or development of a new or improved business component.
• Technical uncertainty must be inherent in the developmental process.
• A process of experimentation must be undertaken in order to eliminate the technical uncertainties encountered during design and development.
• The process of experimentation must rely on one or more of the hard sciences, such as engineering, physics or chemistry.
The many rules and exceptions that make up the R&D tax credit can make companies—especially manufacturers—think that they have no qualified research activities when they actually do. Although traversing these complexities can be difficult, with the help of tax professionals, many manufacturers have found that they do have activities that qualify them for significant R&D tax credits.