Now that you know you can qualify for the R&D tax credit, the next step is to figure out how much you can recover. Keep in mind that working with a professional tax adviser throughout this complex process is the best way to ensure a thorough and accurate claim is prepared for filing.
In the meantime, you can soothe your curiosity and get a general idea of how much credit you may be qualified to receive.
There is a formula that manufacturers can use to calculate end-of-year R&D tax credit which, in itself, may appear a bit complicated. It has to do with the nine steps of the manufacturing process, the percentage of time individuals spend on each step, and their salary.
The Manufacturing Process
Before you plug numbers into an equation, it's important to understand the nine steps of the manufacturing process. Time spent on activities in these areas could qualify as allowable research activities, so it’s important to document meetings and discussions (in-person and remote), discussion topics, and participants throughout the life of the project. Only those activities that meet the Four-Part Test will qualify for the research credit.
Sales Time
Time you spend on these activities during the sales process could qualify for the research credit:
- Understanding the project’s general requirements
- Evaluating technical specifications
- Approving technical specifications
- Quoting the price of the project
Design Meetings
During design meetings with a current or prospective customer, time spent discussing form, fit and function (FFF) can qualify for R&D tax credit.
Flat Blank Layouts
The time spent figuring out the most efficient and cost-effective way to utilize raw materials including experimenting with the materials and evaluating alternatives is eligible for R&D tax credit. Learn more about how the process for flat blank layouts can qualify for the R&D tax credit.
Tool Making
Tool design, tool building, and portions of the trial phase may qualify for the research credit.
Engineering Process
New equipment acquisition and initiatives to optimize the manufacturing process are candidates for the research credit.
Proof of Concept
Time spent building a sample or prototype for the customer can qualify for the research credit, although not all activities qualify.
Trial Production Run
Measuring the first pass yield rate and making adjustments in the production process to improve the yield rate during a trial run can qualify for R&D tax credit.
Quality Approval
Documentation of the production part approval process (PPAP) and the initial sample inspection report (ISIR) is essential to qualifying for the research credit.
Packaging
Developing or improving product packaging can be considered for the research credit depending on what was done in terms of cost, quality or reliability.
The Basic Formula
To calculate the qualified research expense:
(Percent of time employees spend on the manufacturing process) X (Their salary) = Dollar amount that qualifies for the R&D tax credit from employees' salary
In most cases, 7% of your employees' total salary will qualify for the tax credit.
This does not include money you can receive for supplies and contractor research that qualify for the R&D tax credit.
Remember, this formula is for general estimation only. Your tax professional is the best source of advice and information on the exact amount you’ll receive for the research credit.
