Engineering R&D Tax Credit: Maximizing Benefits for Your Engineering Firm
Do engineering firms qualify for the R&D tax credit? The short answer is yes. Engineering companies are eligible for this particular tax refund. We’ll discuss what exactly engineering R&D tax credits mean and what expenses qualify for them.
What are Engineering R&D Tax Credits?
The R&D Tax Credit (26 U.S. Code ยง41) is a federal benefit that provides qualified companies with dollar-for-dollar cash savings for performing activities related to developing, designing, or improving products, processes, formulas, or software. This benefit provides engineering firms with much-needed funds for additional employees, increasing R&D, the means to expand facilities, and much more.
Who qualifies for Engineering R&D Tax Credits?
Pioneering solutions are vital in the engineering industry. That’s why plenty of firms in the industry qualify for this tax savings. The R&D tax credit is available to several sectors, including the following:
- Aerospace Engineering
- Agricultural Engineering
- Biomedical Engineering
- Chemical Engineering
- Civil Engineering
- Computer Engineering
- Construction
- Data Engineering
- Electrical Engineering
- Geological Engineering
- Industrial Engineering
- Manufacturing
- Marine Engineering
- Mechanical Engineering
In general, an engineering firm that engages in the following activities can apply for a Research and Development tax credit:
- Control system design: Firms that create unique computer control programs and produce innovative programmable logic controllers.
- Operation improvement: Companies that create improvements in techniques and methods reduce faults, achieve complex material forms, and develop next-generation capabilities.
- Development of formulations: Companies that overcome problems with material compatibilities, reduce costs, meet regulatory changes, or create new finishes.
- Copy with modifications: Firms that replicate a product, device, or process without infringing patents.
Four-Part Test for Qualifying Activities
An engineering firm must pass a four-part test to qualify for the R&D tax credit program. This test determines whether the firm’s activities qualify for the credit. This applies to all kinds of companies, not just engineering firms.
Permitted Purposes
The activity must relate to a new or improved business component’s function, performance, reliability, quality, or composition. It should intend to develop a new or improved product, process, or software. Moreover, it ensures that the research is not conducted for non-commercial purposes, such as social science research or arts-related endeavors.
Technological in Nature
To qualify for research credits, the activity should fundamentally rely on principles of physical sciences, biological sciences, computer science, or engineering and on scientific methods. This entails that the activity requires the use of technology or engineering in a field of science.
Moreover, it aims to develop or improve a product, process, or software’s functionality, performance, reliability, or quality. Examples include developing new materials, improving manufacturing processes, or enhancing software functionality.
Elimination of Uncertainty
The activity must be intended to discover information to eliminate uncertainty concerning a particular method or capability for developing or improving a product or process. Uncertainty exists if the capability, method, or design of the product, process, or software is uncertain or not readily known.
Process of Experimentation
The activity must constitute the process of experimentation involving simulation, evaluation of alternatives, confirmation of hypotheses through trial and error, testing and modeling, or refining or discarding of hypotheses. It should involve a systematic process designed to evaluate one or more alternatives and include testing hypotheses, modeling, prototyping, and iterative analysis. It also needs to identify uncertainties and test potential solutions to resolve them.
Qualifying Research Activities for Engineering Firms
Most engineering firms qualify for this research credit, but it’s vital to determine which activities qualify for government incentives like the R&D tax credit. Here are some excellent examples engineering firms can refer to:
- Achieve Leadership in Energy and Environmental Design (LEED) certification
- Build information modeling
- Consider and evaluate different design alternatives
- Create prototypes, blueprints, and diagrams
- Design foundation and earthwork for site conditions
- Develop new or improved designs for structures
- Develop new software applications to use internally to interact with customers/vendors
- Develop preliminary design, development plan
- Develop preliminary computer-aided design (CAD) modeling and testing
- Develop schematic designs
- Develop sustainable designs
- Develop unique functional and energy-efficient designs
- Environmental design
- Improve alternative heating or cooling systems
- New materials
- Space utilization
- Toxic waste and other waste disposal processes
Qualifying Research Expenditures for Engineering Firms
Generally, the R&D tax credit covers two categories of qualified research expenses: in-house research expenses and contract research expenses. In-house research expenses include wages paid to employees for any qualifying activities performed, supplies purchased to conduct qualified research, and contract research expenses paid to conduct qualified research.
To clarify, only wages that include all taxable wages reported on an employee’s W-2 form can be declared as qualifying research expenditures. In addition, it should be highlighted that only employees involved in qualified research activities or directly supporting these initiatives are qualified.
Any tangible property bought to conduct qualified research can be considered a supply for this tax credit. An engineering firm working to improve the quality of a product may declare the materials used for that project as supply expenses.
Contract research expenses are when a business performs qualified research on behalf of the taxpayer. In this case, 65% of the amount paid to the non-employee can be considered a qualified expense.
How to Claim Engineering R&D Tax Credits
For these tax savings, companies must seek the assistance of tax credit experts. Miscalculations and wrongful declarations may result in penalties.
For this tax benefit, companies must file IRS Form 6765, Credit for Increasing Research Activities. This process includes identifying qualifying research activities and providing documentation proving these costs meet the Internal Revenue Code Section 41 requirements. Companies may use business records, financial records, oral testimonies, and technical documents.
Before you complete this form, you should familiarize yourself with the instructions mandated by the IRS. The PDF version of this form can be easily downloaded from the IRS website.
In general, the IRS Form 6765 has four sections:
- Section A is used to claim the regular credit and contains 11 lines of required information.
- Section B applies to the Alternative Simplified Credit or ASC.
- Section C identifies additional forms and schedules that require reporting based on one’s business structure.
- Section D only applies to qualified small businesses or QSBs making a payroll tax election.
The IRS recommends that companies calculate their credit using both regular and simplified credit methods, and then they fill out the section (A or B) that would result in the greatest tax benefit.
Benefits of Claiming Engineering R&D Tax Credits
What can engineering companies gain from filing R&D tax credits? Here are some of the benefits of filing research credits:
- Lowered tax liability: Upon receipt of the tax credit, companies can lower their overall tax expenditures.
- Improved cash flow: Companies that receive tax credit services can profit more in the long run because of this credit.
- More budget for R&D activities: Engineering companies can focus on improving their businesses because they have more funding.
- Means for more qualified staff: This tax benefit empowers companies to hire more skilled professionals to contribute to the company’s R&D activities.
How Much Tax Can You Save with an Engineering R&D Credit Offset?
This varies from business to business. Generally, companies can obtain up to $500,000 through the R&D tax credit.
Regular Research Credit
For the traditional method of calculating this amount, you need to calculate the credit as 20% of the excess of current year Qualified Research Expenses (QRE) over a base amount. Most startups use this method, which yields the highest credit for most technology companies.
Alternative Simplified Credit
Companies using the alternative simplified credit (ASC) must provide a 14% credit for QRE exceeding 50% of their average QRE for the preceding tax years.
Claim Engineering R&D Tax Credits Now
Most engineering firms qualify for the R&D tax credit. Every engineering firm involved in R&D should claim tax credits and reduce tax liability. But, claiming them won’t be an easy process. Declaring the correct amount matters, and documentation is vital to avoid issues with the IRS. Contact our team and get in touch with professionals to help you out with claiming these tax credits.
FAQs
What qualifies for R&D tax credits?
Companies that pass the four-part test can apply for Engineering R&D Tax Credits.
Is engineering considered R&D?
Every project among engineers involves some research, especially in the preliminary stages. Yes, engineering qualifies for R&D.
What expenses qualify for the R&D tax credit?
Wages of employees, supply costs, and contract research expenses qualify for the R&D tax credit.