Even if you are simply manufacturing another size of an existing product or making changes to use a new material, your company could qualify for the R&D tax credit. In the eyes of the IRS, 'research and development" includes a number of steps that are common for manufacturers, yet identifying qualified expenses is just the start.
Claiming the R&D credit requires filling out IRS Form 6765 - Credit for Increasing Research Activities, which can be rather complicated.
Understanding Form 6765
At first glance, the form appears simple enough, but the instructions for filling it out properly tell a different story.
Internal Revenue Code (IRC) Section 41, which governs the Research Credit, is complex and minutely detailed. The definition of terms, qualifications, and caveats applying to the credit require an advanced level of understanding.
References to subsections of Section 41 appear throughout the instructions, further complicating one’s ability to process the information.
The best approach is to work with a professional tax accountant or specialist who knows the specifics of the law and your industry. It usually takes a pro to properly identify which of your company’s activities are eligible for the credit, determine the documentation necessary to support the claim, and help you receive the most credit for your research activities.
In order to complete Form 6765, you need to know and provide specific and qualified details such as the following:
- Is your company an eligible small business, a qualified small business, or a member of a controlled group of corporations? The type of business dictates the information you need to provide.
- How will you determine the base period for the research credit? Are you a well-established company or a start-up with less than 3 years of operation?
- Which of your activities fit the definition of qualified research and which activities are not allowed for the research credit?
- Does your qualified project list meet the IRS’ Four-Part test? Activities must meet each of these elements:
- Permitted Purpose. This is the activity intended to make or improve either a product or process that results in improved function, performance, reliability, quality or cost efficiency.
- Technical Uncertainty. This is the activity intended to eliminate technical uncertainty when developing or improving a product or process related to methodology, design, techniques, formulas or inventions.
- Process of Experimentation. This is the activity that includes a process of experimentation to eliminate or resolve technical uncertainty. During the process, various alternatives and approaches are evaluated by modeling, simulation, trial and error, prototyping and other methods.
- Technological in Nature. The process of experimentation must rely on the hard sciences (engineering, physics, biology, chemistry, computer science).
- As part of your documentation process, have you included interviews with appropriate subject matter experts (SMEs) to describe the qualified activities?
- Have you captured all of the qualified wages within the 9 steps of the manufacturing lifecycle that are specific to your industry?
- Have you captured all of your qualified supply expenses and qualified contractor expenses?
An R&D tax specialist can help you collect and organize all the documents you need to support your claim amounts. This is the smartest and most effective way to ensure that you have the most complete and correct information with which to complete Form 6765 and properly file for the research credit.
And remember, a key benefit of working with an R&D tax specialist is that this person (or firm) will stand behind the work performed in the event of an audit.