Update on the R&E Tax Credit
An editorial in the September, 2010 issue of MoldMaking Technology identifies pain points in the moldmaking industry, two of which are the tax burden on businesses and difficulty finding financing options for more efficient equipment to keep up with technology. The Research & Experimentation (R&E) Tax Credit—technically named the Credit for Increasing Research Activities, but commonly referred to as the Research & Experimentation or Research & Development Tax Credit—is a program available to mold manufacturers that addresses both issues by providing a reduction in the tax burden and being a source of potential funding for the cost of equipment and technological improvements.
So, what does this mean to you and your shop? The R&E Tax Credit is a federal tax credit for the development or improvement of products and/or processes. These activities include the design of a new mold or the improvement of an existing mold design subject to several criteria including: the research must be based on science or engineering principles; there must be technological uncertainty relative to the outcome of the project with respect to the capability (“can we do it?”), method (“how do we do it?”) or design (“how do we design it?); and, a process of experimentation must be present, including systematic trial-and-error associated with the development or improvement of the product and/or process—e.g. CAD modeling and CAM simulation.
Some examples of qualified activities in mold manufacturing include design of custom tooling; experimentation with new mold alloys; trial-and-error associated with the development of CNC machine programs and CAM simulation; and, experimentation with improved machining and fabrication processes. There are also activities that are unique and specific to every new job such as the placement and sizing of runners and gates, and the design of ejection and pick-off systems.
Although the R&E Tax Credit has been in existence since the early 1980s and many mold manufacturers have taken advantage of the credit—or have at least investigated the possibility—a recent court ruling in favor of the taxpayer may make the credit more attractive to companies in this industry.
In November 2009, the Tax Court ruled in favor of the taxpayer in regard to mold costs included in a research tax credit claim. The case effectively allows taxpayers to claim as qualified supplies used in the conduct of research amounts paid for molds used in the development and testing of the manufacturing processes. This is only applicable to molds that are sold to the customer (in contrast to molds the company retains ownership to, and subsequently depreciates over its useful life). Prior to this ruling, qualified supply costs were routinely claimed for the cost of prototype tooling only. Taxpayers must be at economic risk for the outcome meaning the company cannot receive compensation from their customer unless the mold performs as required by producing a component that meets the specifications. Once the company has successfully designed and tested its mold (and associated manufacturing process), the ownership of the mold must be transferred to the customer prior to commercial production, even though the taxpayer may retain physical possession of the mold.
Here is a typical scenario of how this could work on a tooling project:
The customer contracts with a plastics component manufacturer to produce a new injection molded part. The component manufacturer conducts a process of experimentation in which the mold is designed along with the development of the manufacturing process and parameters specific to that job, which are needed to produce a part meeting the customer’s specifications. The component manufacturer obtains a prototype mold either from a third-party moldmaker or using internal resources to produce the mold. This allows for the production of a prototype part, likely leading to further experimentation to meet the specifications.
Once approval has been obtained for the prototype part, the component manufacturer obtains the production mold—again either from a third-party moldmaker or internally. Further experimentation is required by the component manufacturer using the production mold to improve the quality of the part to meet the customer’s specifications. Upon receiving approval for the initial run of production parts, the component manufacturer sells the production mold to the customer. In this case, the cost of the prototype and production molds can be claimed as supply costs for the R&E Tax Credit by the component manufacturer. If the component manufacturer retains ownership of the mold, these costs cannot be captured as supply costs. Although the labor associated with the development and improvement of the manufacturing process for the component can be claimed.
The table highlights the facts of the IRS case and shows the value of the TG Missouri credit before and after the Tax Court ruling. It can be seen that prior to the ruling, the production mold costs would not have been included in the eligible research expenditures. After the ruling, the inclusion of these costs was upheld, which dramatically increased the amount of the credit (reduced by the effect of the disallowed wages that had only a minor influence on the amount of the credit).
TG Missouri v. Commission, 133 T.C. No. 13 (2009).
Adam Herman, CPA/ABV/CFF, CVA, ASA; Richard Wile, MBA; and Richard Pickett are members of Mueller Prost PC ’s R&E Tax Credit Group, a division of a regional CPA and business advisory firm located in St. Louis, MO.
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