7 Hidden R&D Expenses in Your Contract Manufacturing Company
What if we told you that there are many opportunities to claim the R&D Tax Credit in your everyday activities that you often take for granted as part of just doing business?
We often hear the phrase “I don’t do R&D. I’m just making a part for my customer, and they’re paying me for it.” We must break that mindset! The R&D Tax Credit was intended for contract manufacturers just as much as it was for the people in the white lab coats trying to develop the next vaccines.
This credit was engineered by the federal government and passed into law. Many states also support the credit, so why not let us help you claim the money you left on the table and allow you to reinvest it back into the business? Often we are able to recover the past 3-4 years of qualified activities, allowing you to reinvest even more.
Just think for a moment, what new piece of equipment would you purchase, or new engineer would you hire that would make you more competitive, win more business, grow faster and be more profitable? The R&D Tax Credit could make that dream a reality. We’ll show you how to safely maximize your credit with our years of hands-on, down-in-the-trenches experience in contract manufacturing.
Black Line Group’s VP and Manufacturing Practice Leader, John Madsen, spent more than 40 years in the manufacturing industry. He helps businesses unpack their processes and identify the activities that occur daily during the various stages of manufacturing — from when the sales team specs new business to the development of new packaging for shipping the final product.
Let’s take a moment and identify some of the common activities built into your processes that could qualify you for the R&D Tax Credit.
1. Sales Time
Taking a customer to lunch or out for a round of golf does not qualify, but any time your salesperson is talking fit, form or function with a customer or potential customer is likely an R&D activity just waiting to be identified.
Your sales team understands your business, and they understand how to help your customers redesign products to save cost and make the product easier to mold, cast or manufacture. The sales team is often the tip of the spear and the start of your process. They gather valuable information like EAU, project life expectancy, how the product will be used with mating parts and a ballpark of what the customer is willing to pay for the part.
This information is handed off to the engineering, quote team or brought into a design meeting. The sales team is the start of the R&D Tax Credit, even if you’re not awarded the business.
2. Design Meetings and Quoting
“Most shops use CAD and some use software to evaluate alternatives before designing,” John explains. “Virtual CAD models can simulate bending and stretching of metals, the flow of molten metal in castings or how plastic will reach all intended areas in a plastic mold. CAD models identify critical areas and allow the designer to make corrections before cutting any steel,” John says. Design teams can then share the results with the tooling experts and salespeople, which can be critical to pricing and understanding risk.
If the design is complex, more time is put into the quote to better understand material reactions and to identify and reduce risk prior to sharing numbers with the customer. The time spent identifying and solving uncertainties with experiments is a qualifying activity.
The time spent quoting new projects or revising quotes due to major design changes are also qualifying activities whether you get the business or not. You spent the time engineering a process, and you should claim your credits for qualified activities.
3. Design Time
Assuming you receive the purchase order, the next step is reviewing the manufacturing quote and design. Ensuring that all the features requested by a customer can actually be developed in your manufacturing process is critical. During this confirmation phase, customer prints or CAD files can often leave the designer with questions. Creating a CAD model allows the designer to communicate potential questions to the customer and with the team building a manufacturing process in your plant.
Once the design has been approved, the needed supplies are identified. After all of this R&D, the materials are then sent to the toolmakers.
4. Tool/Mold/Pattern Making
Once the knowledge transfer from designer to toolmaker is complete, the tool steel is cut into desired rough shapes and ground flat with a surface grinder. Tool paths must then be created for the wire EDM and machining centers.
Some components of the tool may be rough-machined and sent to a supplier for the heat-treating process. Some might also be hardened before machining to help hold tighter punch and die clearances for thin material or complex part designs. Any modifications that are identified and made along the way would likely qualify as R&D.
5. Set-up and the Manufacturing Process
Based on the complexity of the tool/mold/pattern and part design, a set-up and tryout will be part of the process — and a likely place to identify additional R&D tax credits. This can take hours or days depending on how well the flow of material was predicted in the design phase and the number of unexpected issues to be resolved in the manufacturing process.
Once the bugs have been identified and fixed, the customer often requests a trial run to prove the process is capable of producing a consistent and reliable product. Identifying all of the hours spent on these activities is crucial for claiming the R&D Tax Credit.
6. Quality Approval
The quality engineer will randomly sample parts produced by the process to identify any discrepancies or approve the process. A Coordinate Measuring Machine (CMM) is often used to document the findings and relate the consistency from part to part. Based on how well the part matched the print and fell between the upper and lower dimensional control limits, the tool is approved for production or the findings are sent back to the toolmaker for corrections. All of these actions are considered qualifying R&D activities.
Once the part is approved, the information is documented in a PPAP, FI or ISIR and sent to the customer for final approval. If a third-party is used for inspection, this could also qualify for the R&D Tax Credit under the category of contractor research. If you’re a metal caster, you may be required to perform a magnetic particle inspection or x-ray. Identifying contractor invoices as part of the R&D Tax Credit process is an important step to claiming the credits you are entitled to.
7. Shipping and Package Design
Depending on the part shape and/or unique tolerance, a standard box to ship the product may not be an option. Special design considerations may go into the building of the shipping container or reusable packaging. As with the rest of the process, the time devoted to designing, testing and improving new packaging could qualify as R&D.
Apply the Four-Part Test
Once you’ve identified potential qualifying activities, run it through the Four-Part Test to verify:
- 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).
The R&D Tax Credit is a particularly complex and a frequently changing piece of the federal tax code, so it’s best to work with a company that is knowledgeable on your industry and understands the R&D Tax Credit to ensure you’re receiving your fair share.
