With the world becoming increasingly automated, various industries are focusing heavily on improved, faster, and more cost-effective hardware solutions for their products and customers. This requires innovation and creating solutions to enhance computing speed and capabilities.

However, many in the hardware industry are unaware that developing new or improved products or processes can result in R&D tax incentives that can provide significant savings.

To help break down this complex topic, here’s a list of common questions hardware companies have about the R&D credit.

What Is the R&D Tax Credit?

The R&D tax credit is a dollar-for-dollar tax savings that directly reduces a company’s tax liability. There’s no limitation on the amount of expenses and credit that can be claimed each year.

For a thorough look at the federal R&D tax credit—from recent legislative changes to required documentation—please see the Moss Adams Guide to Claiming the Federal R&D Tax Credit.

Examples of applicable activities within the hardware industry are listed below.

How Much Can a Hardware Company Save with R&D Tax Credits?

There’s no limit to how much a company can claim for the R&D credit. However, there are several factors that can impact tax savings. The amount of tax credit available depends on how many qualified costs a company incurs during a specific tax year. See below for details on qualified costs.

In general, a company has the ability to save approximately 7%–10% of annual R&D costs for federal purposes. The savings could be even greater if that company has an income tax filing obligation in a state that also offers an R&D credit.

There are a wide range of companies that can qualify for the R&D credit by designing and manufacturing hardware. Examples include computer boards and chips, self-driving cars, heat mitigation solutions, and many more.

The design, testing, and manufacturing of these products could all potentially qualify for the credit.

Some examples of credits claimed include:

• Heat sink manufacturer with $15 million in revenue generating a $900,000 credit
• Software security and manufacturing firm with $20 million in revenue generating a credit of $235,000
• Medical start-up with $0 in revenue generating a $250,000 credit

What Activities Qualify for the R&D Tax Credit Within the Hardware Industry?

The hardware industry can be simplified into the following categories: engineering and design, testing, and manufacturing.

Engineering and Design

• Design of components used in super computers—chips, circuit boards, and more
• Medical devices, such as braces, tools, and specialized equipment
• Heat sinks used to cool components in complex or high-speed processor applications
• Display modules in aircraft and other aviation applications

Testing

• Performance batch testing for new components for a computer manufacturer
• Stress, heat, and other mechanical testing to verify the component meets performance standards for the application

Manufacturing

• Process design to accurately and efficiently produce new components and hardware
• Design improvements to an existing line to increase through-put of the production line
• Evaluation and testing of new specialized equipment to increase the efficiency of a facility’s production line

Which Expenses Qualify for the R&D Tax Credit?

The R&D credit may be a highly beneficial opportunity for companies in the hardware industry. The tax savings provided from the credit can be used to invest in new equipment or hire highly technical personnel.

Examples of Qualified Research Expenses

Taxable wages paid to employee personnel who conduct qualified research during the year are considered qualified research expenses. Applicable personnel includes engineers, technicians, quality assurance, and managers who design, test, and produce new products for the company.

Relevant examples include:

• Engineers developing autonomous vehicles or new circuit boards for cell phone manufacturers
• Mechanical and process engineers developing new procedures to increase the efficiency of manufacturing new products
• Technicians testing prototypes to develop design improvements
• Contractor and third-party vendors performing qualified research on behalf of the company
• Supplies and prototypes developed for new products—including testing supplies consumed or destroyed during the development of a new product

The success of a prototype doesn’t determine the eligibility of a supply cost. The more a company fails to produce a working product is better for capturing those expenses for the credit.

How Is the R&D Tax Credit Calculated?

To be eligible for the credit, R&D activities must meet IRS criteria known as the four-part test to:

• Demonstrate you’ve attempted to eliminate uncertainty about the development
• Establish you underwent a process capable of evaluating alternatives
• Prove your experimentation relies on science
• Demonstrate the research intended to create a new or improved business component

Completing the steps to pass the four-part test may sound overwhelming and can drain precious time and resources should your business pursue it on your own. Claiming credits incorrectly can also result in the loss of credit and possibly penalties from the IRS. 

Learn the step-by-step approach for claiming the R&D tax credit in our article.

How Long Can R&D Tax Credits Be Carried Forward?

If the federal R&D credit can’t be used immediately or completely, any unused credit can be carried back one year or carried forward for up to 20 years. Each state has its own carryover rules.

In addition, previously filed tax returns can typically be amended for up to three years to claim the R&D credit retrospectively, providing an avenue to recoup previously paid taxes.

New or small business may be eligible to apply the R&D tax credit against their payroll tax for up to five years. The R&D credit is available both at the federal and state level.

What Are the Limitations of R&D Tax Credits?

There are no strict limitations on R&D tax credits when claiming federal credits for a given tax year in terms of a dollar limit. The main factor companies should consider when claiming the R&D credit is whether or not they can utilize the calculated credit amount for a specific tax year. As mentioned, unused federal credits can be carried forward for up to 20 years.

However, the payroll offset option is limited to $250,000 per year for the first five years a company has gross receipts if the company has less than $5 million in gross receipts for each year.  

How Does Your Company Apply for These Credits?

If you think your company may qualify for the R&D credit, the first step is to collect preliminary information about your company’s potential qualified activities.

The relevant information is used to develop an estimate of the credit benefit your company could receive as well as identify other R&D-related tax planning opportunities—so you can make an informed decision about whether an R&D credit analysis is worthwhile for your company.

We’re Here to Help

Each company’s goals, values, and resources are unique, which makes it important to develop a customized project plan to identify, calculate, and support your company’s R&D credits and activities.

With recent increased IRS scrutiny around R&D credits, it’s crucial to understand what’s necessary to substantiate a credit claim.

To learn more about R&D tax credits, see Five Misconceptions about R&D Tax Credits—and if Your Company Qualifies, or request a complimentary credit benefit estimate to see how much your company could save.