Engineering R&D Tax Credit Benefits for Businesses

Robotics and Engineering and the R&D Tax Credit

Small businesses in the engineering sector can significantly benefit from the Research and Development tax credit by reducing their federal tax liability for qualified research activities. For startups with little to no income tax liability, the R&D payroll tax offset is particularly valuable, allowing them to apply the credit against payroll taxes instead. This helps free up cash flow and offset the high costs of paying engineers and technical staff, enabling continuous innovation and growth even in the early stages of development. Leveraging this credit can provide crucial financial support for engineering-focused startups.

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Founded in 1984 by J.W. Norris as Reed & Co., Swanson Reed has grown to become one of the world’s largest firms specializing in Research and Development (R&D) tax credit consulting. We boast numerous publications. Our AI software, TaxTrex, is a cutting-edge AI language model capable of preparing R&D tax credit claims in just 90 minutes. Our R&D audit insurance policy, creditARMOR, is one of the most cost-effective audit management products on the market.

If you have questions or need further assistance, call or email our CEO, Damian Smyth, at (000) 000-0000. Feel free to book a short conference call with one of our national R&D tax credit specialists at a time convenient for you.

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Engineering Case Study

Business Scenario

This case study exemplifies the application of key legislative requirements for eligible R&D activities, applied to relevant activities in the engineering sector.

Hunter Engineering is a family-owned business dedicated to manufacturing custom, eco-friendly hunting products using professional machinery.

With the ban on lead fishing sinkers in the UK, Canada, and various US states due to environmental concerns surrounding them, Hunter Engineering initiated a project with the primary business objective of designing and developing an alternative and improved copper fishing sinker.

The key areas of investigation and experimentation, due to specific technical objectives for Hunter Engineering, were as follows:

Since copper is a much lighter metal than lead, a copper sinker must have a different shape to allow it to sink properly and be cast at a distance.
Since copper erodes much more easily than lead, the development of a coating was necessary.

Following experimentation, Hunter Engineering needed to determine which of its project activities qualified for the Research and Experimentation Tax Credit. To be eligible, Hunter Engineering had to ensure its “qualified research” met four main criteria, known and developed by Congress as the Four-Part Test. Hunter Engineering decided that developing an efficient copper sinker was indeed possible by conducting four R&D activities.

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Eligible R&D Activities of Hunter Engineering

Design and development of a series of prototypes to achieve technical objectives (copper sinker design).

The hypothesis for this activity was whether a lead-free copper fishing sinker could be designed and developed to outperform existing lead fishing weights.

Hunter Engineering created a 3D model of the copper sinker to accurately predict its weight and then sent it to an industry professional for recalculation. Based on the recalculations, Hunter Engineering experts developed the sinker design.

Hunter Engineering concluded that a small increase in the fishing weight’s diameter produced a significant improvement in sinking and flight characteristics.

Testing and data analysis to obtain reproducible results to a satisfactory standard and to test the hypothesis (testing of various coatings and methods for applying lubricant to the sinker).

The hypothesis for this activity was to investigate an optimal coating (or lubricant) that could be applied to the copper sinker to prevent erosion in water.

Each type of lubricant was tested on a batch of fifteen sinkers for over a year. Hunter Engineering tried numerous commercial products, mixing them with other types of lubricants. However, they eventually developed a binder to help the lubricant stay on the copper sinker.

Hunter Engineering found an effective coating that needed to be mixed with the binder and then sprayed onto the sinker before use.

Background research to assess current knowledge gaps and determine feasibility (background research for copper sinker design).

Hunter Engineering conducted the following background research:

Review of final computer-generated calculations for potential specifications for the copper sinker design
Analysis of available competitor products and components
Preliminary review of equipment and resources regarding capacity, performance, and suitability for the project
Consultation with key component/part/assembly suppliers to determine factors they considered important in the design and to gain an understanding of how the design should be structured accordingly

These specific background research activities helped identify the key elements of the research project.

Ongoing analysis of customer or user feedback to improve prototype design (Copper sinker feedback R&D).

Hunter Engineering’s eligible R&D activities during this experimentation phase included:

Continuous analysis and testing to improve the efficiency and environmental safety of the design.
Continuous development and modification to interpret experimental results and draw conclusions that served as starting points for the development of new hypotheses.
Commercial analysis and functionality review.

These activities were considered “qualified research” because they were necessary to evaluate the performance capabilities of the new design in the field and to improve any flaws in the design.

Live Webinar: The R&D Tax Credit in the Robotics, Computer Technology and Engineering Sector

Duration: 60 Minutes

Learning Objectives Include:

An Overview of R&D Tax Credits
Identifying Qualifying Research Activities
Defining the 4-Part Test
How to Substantiate Activities Through Documentation
Identifying Qualifying Research Expenses

Cost: FREE

Knowledge Level: Basic*

R&D Tax Credit Training for the Engineering Sector

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Definition of Qualified Research

Qualified research consists of research with the intent to develop new or improved business components. A business component is defined as any product, process, technique, invention, formula, or software that the taxpayer intends to hold for sale, lease, license, or actual use in the taxpayer’s trade or business.

The Four-Part Test

Activities eligible for the R&D Credit are described in the “Four-Part Test,” which must be satisfied for the activity to qualify as R&D.

Permitted Purpose: The purpose of the activity or project must be to create new (or improve existing) functionality, performance, reliability, or quality of a business component.
Elimination of Uncertainty: The taxpayer must intend to discover information that would eliminate uncertainty regarding the development or improvement of the business component. Uncertainty exists if the information available to the taxpayer does not establish the capability of development or improvement, the method of development or improvement, or the appropriateness of the business component’s design.
Process of Experimentation: The taxpayer must undertake a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or method to achieve that result, or the appropriate design of that result, is uncertain at the beginning of the taxpayer’s research activities.
Technological Nature: The process of experimentation used to discover information must be fundamentally based on principles of hard sciences such as physical or biological sciences, chemistry, engineering, or computer science.

What specific records and documentation did Hunter Engineering keep?

Similar to all tax credits and deductions, Hunter Engineering had to keep business records outlining what they did in their R&D activities, including experimental activities and documents to demonstrate that the work proceeded in a systematic manner.

Unfortunately, the only documentation Hunter Engineering kept was design documents in the form of drawings, leaving ample room for improvement in the area of substantiation.

As a company claiming R&D, you always want to be “compliance ready,” meaning if you were audited, you could present documentation to show the progression of your R&D work. Here are some types of documentation that would be helpful to keep: