Companies have long recognized that outsourcing components of their business to experts can be both cost effective and result in higher quality of results. Whether the industry is manufacturing, accounting, marketing or even payroll, the realization that you should focus on your core and outsource other functions to experts can be the difference between success and failure.
So it is with the contract manufacturing industry.
How can a contract manufacturer qualify for research & development tax credits when they are building someone else’s product?
Contract manufacturers come in many shapes and sizes; some are relatively simple operations that manufacture products requiring very little technical capabilities but can do so at a low-cost and, therefore, bring value to the customer. Other companies are very technology-driven and develop and manufacture products for customers that are intricate, difficult to manufacture or require very rigid design specifications and tolerances to meet their customer’s requirements.
Contract manufacturing can be found in a variety of industries including aerospace, medical device, electronics, automotive, defense, plastic injection molding, extruding, power supply, capital equipment and others. While each performs specific tasks and functions, most provide value through their process and quality.
Process development and improvement are where contract manufacturers can potentially take advantage of the federal and state research and development tax credits.
How do I know if my company will qualify for R&D tax credits?
The research tax credit provides a four-part test that a development activity must pass to qualify for R&D tax credits. You can find more detail in some of our prior blog articles but should start at Navigating the R&D tax credit minefield (part 2).
The key to qualifying for research tax credits will understand what technical uncertainties existed at the beginning of your development effort and what process did you go through to solve those uncertainties.
What questions should I be asking to qualify my activities?
Questions will vary by industry but, in general, a taxpayer should ask themselves the following questions about each project:
When I began this development effort, what did I not know relative to our ability to produce the final product?
Was the original design provided by our customer able to be manufactured? If not, were functional changes to the design made? Why were they necessary?
Was the manufacturing process already developed or did we need to develop a new way to manufacture this product? If new, what did we try that perhaps didn’t work?
Did we produce the final product correctly on the first try? If not, why not?
Have we worked with this material in the past? If not, were there issues related to the material that impeded our manufacturing process? How did we overcome them?
In Part 2 of Contract Manufacturing
In our next blog, we will discuss other tax issues such as using estimates, funded research, substantial rights and process versus product research.
What say you, my friends?
Are you a contract manufacturer that provides value through your processes?
Are you taking advantage of all the state and federal tax incentives available to you?
Are you currently documenting your processes and iterations when things don’t work?
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Randy Eickhoff, CPA is President of Acena Consulting. With more than 20 years of tax and consulting experience, Randy focused on helping companies successfully document and secure tax incentives throughout the US. He has been a long-time speaker nationally as well as conducted numerous training sessions on R&D tax credits and other US tax incentives.