Editor's Note: This blog post is adapted from a transcript of our Manufacturing Minute podcast episode featuring Nick Janda of Specialty Tax Group. The content reflects the conversational nature of the original recording.
Welcome back to the Manufacturing Minute! I'm Megan Meador, audit and insurance partner with Brown Edwards and your host for today's discussion on a topic that could put significant cash back into your business: R&D tax credits.
I recently sat down with Nick Janda, R&D Tax Credit Director at Specialty Tax Group, to explore how manufacturers can take advantage of this often-overlooked tax benefit. As the manufacturing and distribution industry leader at Brown Edwards, I've seen firsthand how this credit can impact companies across our footprint in Virginia, West Virginia, and Tennessee.
What Exactly Is an R&D Tax Credit?
Let me start with the basics. An R&D tax credit is a dollar-for-dollar reduction in your tax liability. If your company is creating something new or substantially improving an existing product, process, technique, formula, or invention, you may qualify.
The key word here is "substantially." We're talking about making something better, cheaper, faster, or stronger. Adding functionality, performance, reliability, or quality to what you already produce. Sound familiar? At the local manufacturing conventions and meetings I attend, I constantly hear about companies developing the next iteration of their products or creating custom solutions for specific customer orders. These are exactly the types of activities that could qualify.
The Financial Impact
Here's where it gets interesting. Nick explained that companies can typically expect somewhere between 8 to 12 cents back for every qualified dollar spent. The credits he's worked on range from $20,000 to $40,000 for smaller operations, all the way up to over$1,000,000 for larger companies.
Just this morning, I was copied on emails about a study his firm completed for one of our mutual clients. The credit was in the six figures. For privately held companies, especially, that kind of cash impact is enormous. It hits the bottom line and provides capital you can reinvest in your business.
What Costs Qualify?
The qualified costs include:
- W-2 wages for employees doing R&D work
- 1099 contractor costs for third parties assisting with R&D
- Scrap materials for prototypes and supplies used in the R&D process
- Cloud computing costs for software developers using AWS, Azure, or Google Cloud
The Four-Part Test
Nick walked me through what he calls the "four-part test" for qualifying R&D activities. Your project needs to have:
- A permitted purpose – your goal of creating something new or improving something existing
- Scientific or technological uncertainty – it must be based in hard sciences like engineering, chemistry, biology, or physics
- A knowledge gap – even as a competent professional, you don't know what design, methodology, or capability will work
- A process of experimentation – think back to high school science class and the scientific method. You establish a hypothesis, test it, evaluate, tweak variables, and try again
Here's something important: the projects don't need to be successful to qualify. If you went through the process but ultimately shelved the project or chalked it up as a learning experience, you can still claim the credit.
Recent Trends and Documentation Requirements
One thing Nick emphasized that I want to highlight: documentation is becoming increasingly critical. The IRS wants to see proof of your R&D activities, including:
- Design documents and CAD drawings
- Email threads discussing technical issues
- Photographs showing iterations
- Slack or Teams conversations
- Calendar invites and meeting minutes
- Documentation showing changes between prototypes
This is where proactive planning becomes essential. I always encourage my clients to have these conversations with their tax professionals early. Meet with us before you start a major R&D project so we can help you understand what documentation you will need. An ounce of prevention is worth a pound of cure, as Nick put it. It's much easier to collect documentation contemporaneously than to scramble months or years later trying to recall what happened.
Common Mistakes to Avoid
Nick shared several pitfalls companies fall into when claiming R&D credits on their own:
Controlled group rules – If you have more than 50% common ownership with other entities, those credits should be evaluated together. This is frequently missed.
Funded research exclusions – If a customer is paying you time and materials for development work, or if they retain all intellectual property rights, that might actually be considered the customer's R&D, not yours.
Claiming too much – Some companies include marketing, travel, meals and entertainment, or general overhead costs like Office 365 subscriptions. These don't qualify.
Claiming too little – On the flip side, companies sometimes miss qualifying costs like pre-production cloud computing expenses.
What About Startups and Loss Companies?
I always get asked: "What if we're not currently in a taxpaying position?" Great question. There are still compelling reasons to pursue R&D credits:
Payroll tax offset – Early-stage startups can use the federal R&D credit to offset FICA payroll taxes on the employer side. You must have less than five million in gross receipts, less than five years of receipts, and can only claim this benefit up to five times. But if you have employees, you're paying payroll tax regardless of profitability.
State benefits – Georgia, for example, allows companies to use the state R&D credit against state employee payroll withholding.
Building your base period – The first year you claim the credit, you're looking at the prior three years to establish your baseline R&D spend. It's easier to do this work sooner rather than later, and when you become taxable, the credit is ready to offset that income.
Beyond Manufacturing
While the Manufacturing Minute focuses on manufacturers and distributors, I found it interesting that Nick has worked with companies across many industries, including brewing and distilling, agriculture, and engineering and architecture.
Taking Action
If you're attending local manufacturing meetings and talking about the newest, coolest thing you're making, or if you're working on custom orders that require developing something new, you should be thinking about R&D credits.
The reality is that many companies are leaving money on the table simply because they don't realize they qualify or they don't understand the process. At Brown Edwards, we're committed to helping our clients identify every opportunity to reduce tax liability and improve cash flow.
If you'd like to explore whether your company qualifies for R&D tax credits, I encourage you to reach out. Visit our website at BECPAs.com to learn more about our services, or contact me directly. Let's have a proactive conversation about how we can help you recoup some of those R&D costs and reinvest them back into your business.
Until next time, this is Megan Meador with the Manufacturing Minute, reminding you that staying informed about trends and opportunities in manufacturing is key to staying competitive.
Megan Meador is an audit and insurance partner with Brown Edwards and the manufacturing and distribution industry leader based in Bristol, Tennessee. Brown Edwards is a top 100 regional firm with offices in Virginia, West Virginia, and Tennessee.
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