Tens of thousands of businesses per year reduce their federal and state tax burden by claiming the R&D Tax Credit. As long as identified expenses pass the law's Four-Part Test, your expenses may qualify as well. Each element of the test - Permitted Purpose, Technical Uncertainty, Process of Experimentation, and Technological in Nature - has specific requirements.
After all, how often are manufacturing activities considered "Technological in Nature?" The answer - More often than you realize. For starters, the test says the research and development must rely on the hard sciences (engineering, physics, biology, chemistry, or computer sciences).
To understand how that occurs in a manufacturing environment, let's look at an example of a typical contract manufacturer / supplier, and walk through some activities that may qualify as "Technological in Nature" during the various stages of their manufacturing process - from the initial sales time all the way through shipping.
1. Sales Time
The contract manufacturer's customers are often experts at designing the end product. They have spent many engineering hours understanding how the electronic components control the function of their device, what strengths and limitations the device may have, and they defined the best product within the cost requirements. Yet, a great contract manufacturer may still contribute improvements to the product during the sales process. For example, the customer may not be an expert in the design of a sheet metal cabinet to better protect the product. Or, the customer may not realize there are hidden costs in the design that could make the final product cost-prohibitive to manufacture.
This is where a good manufacturer will take the time to understand the goals of the design, make suggestions related to fit, form, function, tolerances, construction methods and materials to support the goals of the customer. At this point, the manufacturer will often add design suggestions and comments into the formal quotation, so the customer understands the cost comparisons and how the manufacturer is trying to help the customer achieve their product goals. The time spent identifying, evaluating and suggesting those improvements may very well qualify for the R&D tax credit.
2. Design Meetings
Once the manufacturer is awarded the contract, staff members meet to collaborate on the very best manufacturing method. For example, ideas could include slot and tab construction to greatly reduce the chance of assembly error utilizing a “built-in” weld fixture. Fusion welding the components would eliminate the need for a secondary and costly operation to grind welds flat. Open corners would allow cleaning solutions to drain during the plating and painting process, reducing rejects due to cosmetic imperfections. These improvements could all be considered technological in nature and qualify for the credit.
3. Flat Blank Layouts
Now it’s time to unfold the design and nest the product for maximum utilization of the raw material. Based on volume, tolerance, and size of each component, different manufacturing equipment may be required. Laser, turret, stage tools, progressive dies, or weld fixtures all must be considered to reduce cost and errors and improve profit margin. The solution to these issues depends on the flat blank and the programmer or engineer evaluating the alternatives and may qualify for the credit.
4. Tool Making
The design, build, and tryout of each tool must be verified to confirm each of the components meets the specification required for the construction of the final product. The time spent in the trial process by engineers, tool designers, tool makers, apprentices, and shop floor personnel during this step would likely qualify for the credit.
5. Engineering Process
As the tooling is being built, manufacturing of the product starts to become a reality for the shop floor. New equipment may have been purchased and the shop floor layout may have been redesigned and optimized to improve the flow of the product, reduce wasted movements and allow for a lean manufacturing process. These are all activities that may qualify.
6. Proof of Concept
As components are manufactured, the manufacturing prints and process documentation must be updated with the current process and revision used to make them. Remember, any revisions at this point may cause the manufacturer to return to step 2 or 3 in the process for more adjustments and improvements, increasing the number of qualified activities along the way.
7. Trial Production Run
From the design to raw material to finished product, each tool, process, and concept must be verified to ensure the product is within tolerance and the assembly of the components is within compliance to the standards set by the customer. Does the process need to be improved for flow, cost reduction, performance or reliability? This may require circling back to one of the above steps to make corrections to the part or process. These refinements could often be considered "Technological in Nature."
8. Quality Approval
Once production begins, it's crucial to verify the parts created are within tolerance and that the production process consistently meets those standards. The goal is to verify each component as it is manufactured to reduce waste. Every manufacturer knows you cannot inspect quality into the product, but the FA, PPAP, or ISIR documentation is the customers’ assurance you have your process under control. Testing and verification of these processes is frequently "Technological in Nature."
The last critical component of the contract manufacturer's process requires ensuring the component reaches the customer. If unique package designs are created to prevent damage and preserve the product throughout shipping, those activities may qualify for the R&D Tax Credit.
As you can see, there are many opportunities within this process to use the hard sciences for experimentation. But of course, to qualify for the R&D Tax Credit, it must still meet the other parts of The Four-Part Test.
Remember, the R&D Tax Credit was created to encourage the development of new and/or improved products or processes. Don't miss out on opportunities to claim the credit and reinvest the savings back into your business to be more competitive, grow faster and be more profitable.