Machine Tool and Die R&D Tax Credit Benefits for Businesses

Machine Die and Tool and the R&S Tax Credit

Small businesses in the machine tool and mold sector can significantly benefit from the Research and Development Tax Credit by reducing their federal tax liability for qualifying activities such as custom tool design, manufacturing process improvements, or the development of innovative prototypes. Additionally, startups with limited revenue can take advantage of the R&D tax credit payroll offset, allowing them to apply up to $500,000 per year in credits against payroll taxes, helping to offset labor costs. This incentive supports cash flow, allowing reinvestment in innovation and growth. By leveraging these credits, small businesses can reduce expenses while promoting technological advancements in precision machining and tooling.

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Swanson Reed is one of the few firms in the United States to focus exclusively on R&D tax credit preparation. Swanson Reed provides R&D tax credit preparation and audit services at both the state and federal levels in all 50 states.

If you have questions or need further assistance, please call or send an email to 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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Case Study: Machine Tools and Molds

Business Scenario

This case study demonstrates the application of key legislative requirements for qualifying R&D activities, applied to relevant activities in the machine tool and mold sector.

Southern Machine Tooling (SMT) is an EDM shop specializing in advanced prototype parts for the aerospace and medical sectors and custom tooling. SMT consists of four employees: three in engineering and production and one office manager. Since its founding in 2006, the company has grown with research and development (R&D) at the core of its business activities.

SMT has consistently conducted R&D activities over the years to create new and improved products and processes to operate at the best of its capabilities. Some of SMT’s daily operations include cutting aerospace alloys and hardened steel, aluminum and steel molds, prototype parts, plastics, high-tolerance work (-/-.0001”), aluminum extrusion dies, and tungsten carbide machining.

In 2012, SMT was approached by a client to modify a preformed door panel for an aircraft. The specifications required dozens of holes and several rectangular windows cut from the panel. However, SMT discovered that the panel itself did not conform to specifications, and all features SMT had to machine needed to be cut perpendicular to the curved surfaces they were on. SMT had to design a fixture to hold the part in its correct shape, a device to hold a long electrode so it could be rotated to the correct angle, and create a program that would not only rotate the electrode to the right angle but also position it in the correct hole location relative to a reference established on the fixture.

To qualify for the R&D Tax Credit, SMT had to determine the eligibility of its proposed R&D activities. “Qualified research” must meet four main criteria, known and developed by Congress as the Four-Part Test. SMT’s qualified R&D activities included the following.

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SMT’s Eligible R&D Activities

Design and development of a series of prototypes to achieve technical objectives (door panel design).

SMT develops many tools and prototypes starting from ideas, sample parts, or rough sketches. When SMT creates components for the aerospace and medical sectors, the design is generally provided. SMT’s engineering focuses on developing a precision manufacturing method so that the parts meet the highly technical and extremely precise design requirements presented by clients.

SMT’s hypothesis for this activity questioned the possibility of designing a door panel that met space specifications and requirements.

Experiments conducted by SMT in the design phase involved predominantly computer modeling, conceptual engineering drawings, and mathematical calculations. These experiments could only be proven effective or ineffective during the prototype development and testing phase.

Following experiments in that phase, during which the process was tested in various applications, the design was modified and re-tested until the desired result was achieved.

Testing and data analysis to achieve reproducible results to a satisfactory standard (door panel development and testing).

The main objective of this activity was to prove that, with better knowledge of the intrinsic factors related to the process required to modify the door panel, it was possible to produce the panel according to the necessary specifications.

Details of this experiment included the development of the fixture to hold the panel in its correct shape, the development of a device to hold a long electrode, and the development of a program to rotate the electrode to the correct angle.

Background research to assess current knowledge gaps and determine feasibility (background research on SMT process development).

In addition to the lack of comparable solutions available, the results of this research activity could not be known or determined in advance due to a series of specific technical challenges.

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

Literature search and review, including maintaining up-to-date knowledge on relevant certifications and standards.
Consultation with industry professionals and potential clients to determine the level of interest and commercial feasibility of the product.
Preliminary review of equipment and resources regarding capacity, performance, and suitability for the project.
Consultation with key component/part/assembly suppliers to determine the factors they considered important in the design and to understand how the design should be structured accordingly.

The background research conducted by SMT was directly related to the main objective of designing an improved metal vaporization process, thus qualifying as R&D.

Ongoing analysis of customer or user feedback to improve prototype design (R&D on interpretation software feedback).

SMT’s eligible R&D activities for this phase of its project included:

Continuous analysis and testing to improve project efficiency and safety.
Continuous development and modifications to interpret experimental results and draw conclusions that served as a starting point for the development of new hypotheses.
Commercial analysis and functionality review.

These activities were necessary to evaluate the performance capabilities of the new design in the field and to improve any design flaws, thus qualifying as R&D.

Live Webinar: R&D Tax Credit in the Machine Die and Tool, and Defense 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 Machine Tool and Die 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 met 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 of achieving that result, or the appropriate design of that result, is uncertain at the beginning of the taxpayer’s research activities.
Technological in Nature: The process of experimentation used to discover information must fundamentally rely on the principles of hard sciences such as physical or biological sciences, chemistry, engineering, or computer science.

What specific records and documentation did SMT keep?

Similar to any tax credit or deduction, SMT had to keep business records describing what it did in its R&D activities, including experimental activities and documents to prove that the work took place in a systematic manner. SMT kept the following documentation:

Project logs / lab notes
Innovation Log
Conceptual sketches
Design drawings
Literature review
Background research
Change logs
Test protocols
Test/trial analysis recording results
Resource allocation/usage logs
Staff timesheets
Tax invoices
Receipts

By having these documents on file, SMT confirmed it was “compliance ready,” meaning that if it were audited, it could present documentation showing the progression of its R&D work, ultimately proving its R&D eligibility.