Innovation plays a key role in the manufacturing industry. From developing new products and materials to improving production processes, manufacturers are constantly working to solve technical challenges and improve performance.
The R&D (Research and Development) Tax Credit can help businesses recover some of the costs associated with this investment in innovation, but what does qualifying R&D look like for manufacturing companies?
What Manufacturing Activities Could Qualify?
R&D in manufacturing can cover a wide range of projects. Your business may be carrying out qualifying R&D when it is working to develop or improve a product, process, material, formula, technique or software. Examples could include:
- Developing new or improved products
- Developing new manufacturing processes
- Testing alternative materials or components
- Designing and testing prototypes
- Improving product performance or reliability
- Developing new production techniques
- Improving manufacturing efficiency
- Developing or improving automated processes
- Testing different technical solutions to overcome a challenge
The important factor is that the project involves technical uncertainty and a process of experimentation to find a solution.
The Four-Part Test
The activity must be intended to create a new or improved business component, with improvements tied to function, performance, reliability, or quality. Changes that are purely aesthetic, cosmetic, or seasonal do not qualify.
Permitted Purpose
The project must aim to develop or improve a product, process, technique, formula, invention or software.
Technological in Nature
The work must rely on principles from areas such as engineering, computer science or the physical sciences.
Technical Uncertainty
There must be technical uncertainty about how to achieve the desired result, whether something can be developed or how it should be designed.
Process of Experimentation
The business must test and evaluate different approaches to find the right solution. This could involve prototyping, modeling, testing or iterative trial and error.
What Costs Could Be Included?
Once qualifying R&D activities have been identified, businesses can look at the costs associated with that work.
For manufacturers, this can include:
- Employee wages for staff involved in qualifying R&D
- Supplies used during the development and testing process
- Qualifying contract research costs
- Cloud Costs: related to development of new programs or manufacturing/enterprise management systems
For example, a manufacturer developing a new product may have engineers designing and testing prototypes, employees carrying out experimentation and various raw material combinations being used during the development process. These costs may form part of the R&D tax credit calculation where they meet the relevant requirements.
Why Is Documentation Important?
Good documentation can help demonstrate the work that was carried out and the costs associated with it.
This could include:
- Project and design records
- Testing results
- Prototype information
- Technical documentation
- Details of employee involvement
- Financial and accounting records
The strongest claims are supported by a clear link between the technical work undertaken and the costs being claimed.
How Does Section 174/174A Fit In?
The R&D Tax Credit and the tax treatment of research and experimental expenditure are separate areas, but they should be considered together.
Section 41 determines whether activities and associated costs qualify for the R&D Tax Credit.
Sections 174 and 174A relate to how research and experimental expenditures are treated for tax purposes.
For tax years beginning after December 31 2024, Section 174A generally allows businesses to deduct qualifying domestic research and experimental expenditures in the year it is paid or incurred, subject to the applicable rules.
Understanding how these rules work together can help manufacturers make informed decisions about their R&D activity and wider tax position.
Could Your Manufacturing Business Be Missing Out?
R&D does not always happen in a dedicated research facility. It can take place on the production floor, in engineering teams, during product development or while testing new processes and materials.
If your business is investing in product development, process improvements, automation, materials development or technical problem-solving, it may be worth reviewing whether those activities could qualify for the R&D Tax Credit.
At CBTax, our specialists can help businesses identify qualifying R&D activity, assess associated costs and understand the Federal and State R&D tax credit opportunities available.
Could your manufacturing business be making more of its R&D investment? Get in touch with us to find out more.