Innovation is crucial to ensuring the long-term success of manufacturers in Illinois and across the country. The 2017 Manufacturing Report from professional services firm Sikich LLP found that many manufacturers understand this and view new product development as a priority. In fact, according to the report, nearly one-third of respondents identified new product or service development as their biggest opportunity for growth in the next 12 to 18 months.
At the same time, not all manufacturers are doing enough to take advantage of important related tax credits. Our report found that half of respondents said they are not taking advantage of R&D tax credits.
If a manufacturer fails to reduce its tax burden by using available tax credits, it risks putting itself at a significant competitive disadvantage. R&D tax credits typically equal 5 percent to 7 percent of manufacturers' R&D expenses. That means a manufacturer spending $1 million on R&D could save approximately $50,000 by applying for the tax credit.
Level the playing field
As part of the PATH Act of 2015, Congress made the research and experimentation credit, which had been in place since 1981 and renewed annually, permanent. It also allowed small businesses (defined as those with $50 million or less in average gross receipts in the prior three years), to use R&D credits to offset the alternative minimum tax.
Many foreign countries use the tax code to create incentives for R&D more than the U.S. does, so this was an important step aimed at making U.S. manufacturers more competitive versus their foreign counterparts. Many states, including Illinois, have their own R&D tax credits as well.
Though manufacturers know about these tax credits, many often assume that most of their activities don't qualify. But the reality is that a manufacturer does not need to have scientists in lab coats inventing revolutionary products to take advantage of R&D tax credits. Many day-to-day engineering and design activities qualify, including process or product improvements, as well as software developed internally.
The confusion over what qualifies for R&D tax credits leads many manufacturers to vastly underestimate the time and money they spend on R&D-related activities. As a result, they could be missing out on thousands of dollars in reduced tax burden annually.
Qualify for the credit
To ensure they take full advantage of available R&D tax credits, manufacturers should start by reviewing all the activities in their operations to see where they align with the qualifying activities under the law. The wages of employees participating in R&D activities, as well as some costs for materials, are used to calculate the tax credit. Therefore, it's also important that manufacturers institute processes that enable them to easily track hours spent on different R&D activities.
There are firms that specialize in R&D credit studies that can help a manufacturer accurately identify qualifying activities and create and maintain the proper documentation, which is crucial in the event of an audit.
Manufacturers have three years to claim the federal credit, which means they can amend returns from as far back as 2014. By scrutinizing their activities and enlisting the help of a third-party expert, manufacturers can ensure they are fully rewarded for their R&D activities.
In today's economy, competition is fierce for all manufacturers. As a result, companies need to work hard to ensure every competitive advantage. R&D and product innovation is of course necessary for manufacturers to continue to grow. Available tax credits simply reward manufacturers for the innovation they carry out on a daily basis.
Taking advantage of R&D tax credits will reduce a manufacturer's overall tax burden to give it more money to reinvest into its business and improve competitiveness. Manufacturers need to make R&D tax credits a priority and ensure they don't leave money on the table.
• Jerry Murphy, partner-in-charge of the manufacturing and distribution practice at Sikich LLP.