How to Claim R&D Tax Credits for Engineering in 2024

Engineering firms stand to gain quite a bit of savings from the IRS’s Research and Development Tax Credit. The credit is designed to provide tax relief to companies doing innovative and scientifically progressive work, which many engineering firms’ work falls under.

The following article will cover how engineering firms can take advantage of the R&D tax credit in 2024, what kinds of activities qualify, and how to claim it. Let’s take a look.

What is the R&D Tax Credit?

The research and development tax credit encourages businesses to innovate and think ahead. It credits an average of 6.5-10% of QREs (Qualified Research Expenditures) including wages, supply costs, and contracted research expenses.

The R&D tax credit applies mainly to small and medium-sized businesses. It provides tax incentives for:

• Developing new products or services
• Improvements in old products or services
• The creation or testing of new prototypes 

How Does the Research & Development Tax Credit Work?

The R&D tax credit provides tax breaks to companies that conduct research and develop new products, improvements, and other innovations.

If the firm has been in business for less than 5 years and has less than 5 million in gross receipts, the R&D tax credit can be applied to payroll taxes. This allows firms that have yet to profit to benefit.  

Can Engineering Firms Claim The R&D Tax Credit?

Yes, engineering firms can claim the R&D tax credit for qualified research expenses. The credit is designed to encourage innovation and development by providing a tax incentive for companies that invest in R&D, amongst which engineering firms perform a great deal.

At first, many people thought the R&D tax credit would apply mainly to research in fundamental sciences. However, through the efforts of many different kinds of companies in various court cases, a greater breadth of industries now have precedents to qualify. 

How to Claim R&D Tax Credits for Engineering

The main steps to claiming the R&D tax credit are to confirm which activities may qualify and then speak to a licensed tax attorney to maximize your potential claim. 

Check Your Eligibility

To be eligible for the R&D tax credits for engineering, you must be engaged in qualified research activities. These activities must be technological and involve experimentation to develop or improve a product, process, or software.

The Four-Part Test

To qualify for the R&D Tax Credit, your projects must be engaged in activities that pass the four-part test that was created by the precedent set by the 2023 IRS case:

1. Permitted Purpose – The project aims to create or improve the functionality, performance, reliability, or quality of a business component.
2. Elimination of Uncertainty – The project begins with uncertainty about how to achieve the project goal and involves work to eliminate this uncertainty.
3. Process of Experimentation – The project involves a systematic process of experimentation by evaluating one or more alternatives.
4. Technological in Nature – The experimentation relies on the hard sciences, such as engineering or computer science.

Although still somewhat subjective, using previous examples to show that one’s efforts fall within the four parts is the most straightforward way to claim your case.

Speak to a Tax Planning Team

Claiming R&D tax credits can be complex, so hiring a tax planning team with experience in this area is essential. They can help you to:

• Identify and document your qualified expenses.
• Maximize your benefits by taking advantage of all eligible activities.
• Prepare and submit your claim to the IRS.

• Represent you in case of an audit or inquiry from the IRS.

Examples of R&D for Engineers

As an engineer, you may be involved in various research and development (R&D) activities that are eligible for the R&D tax credit. Here are three concrete examples of qualifying projects an engineering firm may perform:

1. Developing a New Product

Imagine you're a mechanical engineer working for engineering companies specializing in the design and manufacturing of industrial machinery. 

Your team has been tasked with developing a new generation of high-efficiency pumps that reduce energy consumption by at least 20%. 

To accomplish this, you realize you’ll need to conduct extensive research and experimentation to develop new materials, design novel geometries, and test various prototypes until the requirement is fulfilled.

These qualify as R&D activities and are eligible for R&D tax incentives.

2) Improving a Manufacturing Process

Next, suppose you're a manufacturing engineer working for a company that produces automotive parts. 

Your team has been tasked with improving the efficiency of the production line by reducing waste products and increasing its throughput. 

To achieve this, you'll need to design and test new manufacturing processes, such as implementing automation, optimizing workflows, and conducting experiments to reduce material waste. 

Because this uses experimentation to improve a process, it also qualifies under R&D Tax incentives for engineering.

3) Developing Custom Software

Finally, let’s take the example of a software engineer. You're working for a company that develops custom software solutions for the energy industry. 

Your team is working on developing a new software platform that can analyze energy usage patterns to provide real-time energy efficiency recommendations to their customers.

To achieve this, you'll need to research and experiment to develop the code and algorithms, design and test software prototypes, and integrate with the company's legacy systems.

Even though the experimentation is all simulated, software engineering can also qualify for the R&D tax credits for engineering, as computer science is also considered a hard science.

How The IRS Calculates the R&D Credit

The IRS uses two primary methods for calculating the R&D tax credit: the traditional and the Alternative Simplified Credit (ASC) method.

1. Traditional method – Document and calculate 20% of research expenses over a base amount. The base amount is a fixed-base percentage multiplied by the average annual gross receipts for the last 4 years.
2. Alternative Simplified Credit (ASC) method – This method calculates the credit based on 14% of the qualified research expenses (QREs) that exceed 50% of the average QREs for the 3 preceding tax years. If the company had no research expenses in any of the previous three years, the credit is 6% of the QREs for the current year​​.

The approach you should choose depends on the calculation method that best suits a company’s financial situation and R&D spending patterns.

How Much Can Engineering Companies Earn from the R&D Tax Credit?

Typically, the R&D tax credit is worth up to 20% of your qualified research expenses.

However, the credit depends on various factors, including your company’s tax liability and applicable tax rate. You should consult with a licensed tax consultant to confirm how much your engineering firm may be qualified for. 

It is also possible to work to find and design more projects that count as qualified research expenses to maximize the credit. 

Frequently Asked Questions

How Far Back Can You Claim R&D Tax Credits?

You can claim R&D Tax Credits for the last 3 tax years.

If your company has missed out, you still have a chance to amend past returns and get the credit.

This could lead to significant savings on already completed research and development initiatives.

Is Engineering Considered R&D?

Yes, engineering is considered research and development when experimentation is used to develop or improve a product, process, or software. Most engineering projects fall under these parameters. 

How Should Engineers Document R&D Expenses?

To claim the R&D tax credit for engineers, engineering firms must document their expenses and provide supporting documentation to the IRS. These expenses can include:

• Labor Costs: Salaries, wages, and benefits for employees involved in R&D activities
• Contractor Costs: Fees paid to contractors or consultants for R&D services
• Materials and Supplies: Costs of materials, equipment, and software used in R&D activities

What Doesn’t Qualify for the Credit as an Engineering Firm?

Some activities do not qualify for the R&D tax credit as an engineering firm. This includes research that is:

• Conducted outside the United States
• In the social sciences, arts, or humanities
• Funded by a government grant or contract
• Conducted after commercial production has begun

Start Your R&D Claim - Do You Qualify?

At RevenueSafe, we explore a business’s R&D methods and expenses to ensure a compliant claim of maximum value. Our process is simple, straightforward, and easy to use. So don’t wait, take the opportunity now to save money for your business.