by Adam J. Herman, CPA/ABV, CVA, ASA and Michael J. Devereux II
The Research & Experimentation (R&E) tax credit – also known as the Research & Development (R&D) tax credit – is now available to plastic molders and processors for such activities as designing molds or parts to meet customer specifications, improving customer designs, and refining or developing manufacturing processes.
ABOUT R&E TAX CREDITS
The R&E tax credit has been in existence since 1981, but recent regulations have relaxed the definition of qualified research activities and the record keeping requirements. Consequently, many companies that were not eligible in the past may now take advantage of this federal tax credit. Furthermore, the changes to the governing regulations are retro-active, meaning companies may file amended tax returns to obtain refunds of previously paid income taxes. In some cases, companies may recapture taxes paid up to four years ago.
The R&E tax credit is a wage-based tax credit available for the development or improvement of products, processes, techniques, formulas, inventions or software. In addition to R&E wages, companies may capture supply costs for prototypes, as well as 65 percent of contracted labor used during the development process. This tax credit is available to all entities filing a federal tax return. In addition, more than 30 states offer a modified R&E tax credit.
Companies can benefit by both deducting the research expenditures and by claiming the credit. While the research expenditures are a reduction of taxable income, the R&E tax credit is a dollar-for-dollar reduction of tax. In addition, any fees paid to advisors for documenting the credit are deductible in the year paid.
The R&E credit is calculated by comparing recent years research activities to a base amount with 20 percent of the increase in activities captured as the tax credit.
Companies must first use the credit to offset tax for the year the credit is generated. However, if additional credit remains, the company may carry the credit back one previous tax year or forward to the next 20 years
There are three basic requirements for research activities to qualify:
1. Qualified research activities are defined as the development or improvement to a business component, which is defined as a product, process, technique, formula, invention or software.
Plastic manufacturers are continually developing or designing custom parts and products to meet customer specifications. Most molds and parts are unique products for the plastics manufacturer and constitute a business component.
2. The research must be technological in nature. That is, the process of experimentation used to discover the information fundamentally relies upon the physical or biological sciences, engineering or computer science. Furthermore, companies may use existing technologies and may rely upon existing principles to satisfy this requirement.
Plastic manufacturers rely heavily on the principles of the physical and engineering sciences to develop or improve their products or processes.
3. The research must be intended to eliminate uncertainty concerning the development or improvement of a business component. Uncertainty exists if the capability or method for developing the business component is unknown, or if the appropriate design of the business component is unknown.
Plastic manufacturers are constantly searching for more efficient and more effective ways to design or build parts. There is an endless supply of design specifications and alternatives to be considered in designing a part and/or the mold gate specifications, runner specifications, mold actions including ejection issues, cavity specifications, overflow/flashing issues, venting issues, and draft issues all of which are uncertain at the outset of the part design and manufacturing process.
COMMON MYTHS ADDRESSED
Myth:We are a small company. This credit is just for big business.
There is no size requirement for the R&E credit. Both large and small companies are potential candidates for the credit. If you have improved your products or processes, you may be eligible.
Myth:Well just tell our CPA to file the right form at the end of the year to receive the credit.
Successfully claiming the R&E tax credit is more complicated than just filing the appropriate form. Highly specialized knowledge of current and historical requirements is necessary to substantiate and defend your claim.
Myth:Our CPA looked into this a few years ago. We didnt qualify.
Recent changes to Treasury regulations have changed the definition of qualified research, allowing many more manufacturers activities to qualify.
Myth:Im not sure the credit is worth the time and energy.
The credit is worth the time and energy. Due to the relaxed definition of qualified activities, credit amounts tend to be significant and the process of documentation is designed not to disrupt operations.
The Research & Experimentation tax credit is an excellent instrument to retain cash in a company. As a company in an ever-evolving industry, the credit provides an opportunity to offset some risk assumed by the company and encourages constant innovation.
Adam Herman, CPA/ABV, CVA, ASA and Michael Devereux are members of MPP&W, P.C.s R&E Tax Credit Group, a division of a regional, St. Louis-based CPA and business advisory firm. The R&E Tax Credit Group specializes in assisting manufacturers and their advisors in maximizing the R&E tax credit. Mr. Herman and Mr. Devereux will be presenting on the R&E tax credit at the next MAPP Forum on October 13, 2006. For more details, call (314) 862-2070 orvisit www.mppw.com/RE.