Automation continues to revolutionize the economy, but many thriving companies are not utilizing federal and state tax credits and incentives in the area of research and development that support Industry 4.0 adoption and growth, according to Clayton & McKervey, an international certified public accounting and business advisory firm located in metro Detroit. Sarah Russell, CPA, a Clayton & McKervey shareholder who advises clients on Research & Development tax strategies, believes there has never been a better opportunity for businesses—including “smart” manufacturers—to explore and capitalize on these cash savings.
“Real-time data, combined with an understanding of the impact of tax credits and incentives, can often make a business more nimble and competitive,” Russell said. “The Research & Development (R&D) tax credit, also known as the R&D tax credit, has given businesses a powerful tool to strategically improve their bottom line, but it is often overlooked or unclaimed—even with the new tax law.”
The R&D benefit is available for the development or improvement of products, processes, techniques, formulas, inventions or software and is a dollar-for-dollar credit against the taxpayer’s federal income tax liability, which means companies may get a twofold benefit—the deduction in the year the expenditure is paid, as well as by claiming the tax credit.
Tim Finerty, CPA, a Clayton & McKervey shareholder who addresses the needs of growth-driven businesses in the manufacturing, system integrator, distribution and service related industries, says that some of the best candidates for the R&D tax credit are companies that have business related to technology, industrial production and design, but also some machine shops, tool and die shops, and custom machine manufacturers.
“S-corporations, start-ups and partnerships in the business of improving industrial production processes through controls, automation or system integration should definitely consider the R&D tax credit,” Finerty said, “but many of these businesses are thinking about converting to a C-Corp structure under the new tax law.”
Before a change in structure, Finerty cautions that additional factors should be considered like whether the business qualifies for the pass-through deduction; if the business generates research credits; whether the business will pay dividends to its owners; and the long-term exit strategy of the business.
“The answer lies in the way the tax law is written,” Finerty said. “R&D credits generated by a business can be used to offset any income generated from that same business activity, so converting to a C-Corp may not be the best solution.”
Russell and Finerty outline examples of Qualified Research Activities (QRAs) under the R&D credit:
- Providing custom control and automation solutions for various applications
- Developing new functionality or performance to meet customer specifications
- Development of schematic drawings for integration of system components
- Designing and developing cost-effective and innovative operational processes
- Developing new tool-specific fixturing or other tooling
- Improving processes through robotics or other types of automation techniques
- Experimenting with new alloys or other materials
- Testing new mold/die designs through sampling or trial
- Providing product and system solutions, including design engineering and mechanical fabrication
- Performing evaluations and system test
- Implementation of automated systems
There may also be Qualified Research Expenditures (QREs) if companies can substantiate how the expenditures are connected to the qualified activities including:
- Qualified Wages of Employees performing qualified activities, supervising qualified activities and supporting qualified activities
- Supplies used to fabricate prototypes/items consumed during the conduct of research
- Contract Research–65 percent of fees paid to outside consultants/subcontractors/ engineers/software developers
- Estimates are allowed, however documentation of how the estimates were determined must be provided and reasonable methods must be used
Tax savings can be extensive; for example, one Clayton & McKervey client that designs, manufactures and installs purification systems tallied an approximate R&D tax credit of $1 million for 2014-17; another client who manufactures and installs integrated cleaning solutions for industrial applications will get a $475,000 in an R&D tax credit. Other examples of companies benfitting from the R&E tax credit are a designer and manufacturer of custom container and packaging products that saved almost a half-million dollars and a company that designs and builds custom conveyor systems that saved $1.4 million over three years.
“It’s definitely worth it for companies, especially those who have moved forward with an Industry 4.0 approach, to take a second look at its qualified research activites to make sure it’s receiving all the money it can,” Russell said.
