How the R&D tax credit rewards job shops and contract manufacturers

Enacted in the 1980s, the R&D tax credit is an incentive created by Congress to help U.S. industry where it needed help the most: where innovation happens. The real action in innovation and job expansion happens among the countless small companies that have just dozens of employees, so why not take advantage of this tax break? Getty Images

Contract manufacturers and job shops have become among the most viable options for U.S. OEMs to remain agile and beat foreign competition. These shops are not only helping to create jobs in the U.S., but they are helping other American businesses save on costs and improve their bottom lines so they can grow year after year.

While contract manufacturers remain a source of savings and agility for U.S. businesses, they too are looking to improve their processes. When the U.S. government saw the need for the types of innovations that would push forward businesses like contract manufacturers, it developed a tax credit as an incentive for creating new products and processes or improving existing ones.

Seeing the Need for Innovation

The incentive is called the Research and Development (R&D) Tax Credit, and it has helped U.S. small businesses claim roughly $10 billion a year in federal tax savings—monies that these companies can put right back into their business to hire new talent, purchase new equipment, or plan for future growth.

The R&D credit was enacted in the early 1980s to stimulate economic growth and drive domestic business. It offers U.S. businesses (and specifically U.S.) the chance to receive significant tax relief for what often amounts to their daily work on client projects.

Consistent Credit Changes

The incentive has only been strengthened by Congress throughout the years, with judicial activity and legislative adaptations widening the lane, and increasing the number of U.S. businesses who qualify for the credit.

For example, the Protecting Americans from Tax Hikes Act (PATH Act) made the credit a permanent fixture of the U.S. tax code. Another significant change came with the Alternative Minimum Tax (AMT) turnoff, which allows small businesses—defined as companies with less than $50 million in gross receipts—to claim the R&D credit against their AMT. The AMT was the single biggest barrier preventing eligible companies from claiming the incentive, so its removal has benefited small to mid-sized companies substantially.

The most recent changes have resulted from the passage of the Tax Cuts and Jobs Act. Contract manufacturers shouldn’t turn a blind eye to this tax-saving opportunity, particularly because this legislation expanded individual AMT relief and eliminated the corporate AMT. Taken together, these changes have a large impact on the number of businesses that can benefit from this incentive.

What Makes Contract Manufacturers a Good Fit?

The R&D tax credit isn’t just about basic research; it’s also about applied research. The incentive rewards contract manufacturers who bring a new or improved product to market, as well as those who are improving the manufacturing process itself.

The technical problem-solving that manufacturers perform every day to improve an existing product, the steps they take on the factory floor to solve a production issue to make that product, or even the trial-and-error they perform to ensure the product meets a client’s specifications all qualify these businesses for the credit.

Countless production and design specializations make precision machine shops, fabricators, stampers and other manufacturing companies potentially eligible for substantial tax savings.

Here are some examples of qualifying activities that have led companies to large returns:

• Integrating new materials to improve product performance or manufacturing processes (or both)

• Prototyping and 3D solid modeling

• Achieving compliance with changing emissions laws and regulations

• Streamlining manufacturing processes through automation

• Programming essentially anything—a PLC, CNC, SCADA

• Exploring new or improved material applications and testing alternative uses of metal alloys

So how valuable can the R&D Tax Credit be for a contract manufacturer? The result depends on the supplies consumed and the wages paid when working on the specific project. This includes all of the activities: ideation, design, testing, and production.

Editor’s note: Business Briefs columns address topics pertinent to small businesses, such as tax credit legislation, business asset protection, and cybersecurity.