Plastics and the R&D Tax Credit An Often Overlooked Opportunity by the Numbers

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Tax Credit Co | 6255 Sunset Blvd | Suite 2200 | Los Angeles, CA 90028

Plastics and the R&D Tax Credit

An Often Overlooked Opportunity by the Numbers

With tax time upon us once again, companies are looking to minimize their tax burden. There are a variety of tax credits in place intended to incentivize certain activities which reduce tax liability, including the Research & Development tax credits. However, despite the existence of qualified activity, the data reveals that the plastics and rubber industry is not maximizing their R&D credit opportunities:

 The average benefit for a plastics and rubber company claiming the credit is $115,000 – the second lowest among manufacturing industries.

 Of the manufacturing sectors, plastics and rubber only claims 0.68% of the total credit claimed, despite being the third largest subsector of American manufacturing.

 To slice the data another way, plastics and rubber only claim 3.8% of their booked R&D expenditures towards the R&D credit, whereas primary metals, for example, claims 57.7% – comparatively 15 times higher than that of plastics and rubbers, despite spending drastically less on R&D

Those in the industry who are claiming the credit, however, do get value from their efforts – plastic and rubber companies claiming the credit receive about a nickel back for every dollar spent on qualified expense. Though many have heard of the R&D tax credit, this article will cover three core topics relevant to the plastics and rubber manufacturers:

1. History and Purpose of the R&D Tax Credit 2. Examples of Qualifying Expenditures in Plastics 3. Preparing an R&D Credit Claim

$.0B $.5B $1.0B $1.5B $2.0B

Plastics Primary Metals

QRE Portion of Booked R&D

QRE Unclaimed

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History and Purpose of the R&D Tax Credit

The R&D credit was enacted in 1981 as a temporary provision of the US Internal Revenue Code. It has bipartisan support and has been renewed 16 times to date. The benefit is not a deduction, but rather a dollar-for-dollar reduction of a company or individual’s federal income tax liability. Any unused credits can be carried back one year and forward twenty. Most states have R&D credits as well, including states without income tax, such as Texas. A business can claim credits worth 5% to14% of their qualified research expenditures (QRE).

There are three categories of QRE:

1. Wages for employees engaged in, supporting or supervising qualified activity

2. 3rd_{Party Contractor Costs}_{for contractors performing qualified activity on your behalf} 3. Supply Costs for prototypes, material, and supplies used in the qualified activity The tax code uses a 4-part test to determine what activities qualify. Activities must be:

1. Intended to develop a new or improved product, process or software

2. Reliant upon the sciences, such as engineering, biology, physics or computer science 3. Intended to eliminate technical uncertainty in capability, method or design

4. Part of a process of experimentation to evaluate alternatives

In the typical product development lifecycle, qualifying activity generally begins with the conception of an idea and continues up to the point when the product or software is ready to be mass produced or deployed:

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Qualifying Expenditures in Plastics and Rubber

The plastics and rubber sector is extremely innovative relative to other industries. One out of every four companies in the plastics and rubber sector has a patent whereas manufacturing on the whole averages one in twenty-two.

Although there is a safe harbor in the Internal Revenue Code for patents, it is far from being a requirement to qualify for the credit. Whether you are working on innovative 3D printing technology or attempting to reduce the materials used in your standard plastic container, the effort does not have to be new to the industry, just new to you, the taxpayer. Moreover, the Code makes clear that the level of technological advancement brought out by the research activities is not considered in determining if the costs are QRE1_{. Rather the determinative factor}

is the nature of the activities to which the expenditures relate2_.

In fact, the process to develop any new or improved plastic product likely have some activities that qualify for the credit. Examples are provided in the table below:

Technical Uncertainties in Plastics Development

Resistance to chemicals

Weight reduction Stretchability

Thermal insulation Flexibility Cotton characteristics

Electrical Insulation Moldability Wool fiber

characteristics

Silk characteristics Porcelain and marble

characteristics

Aluminum and zinc characteristics Renewable alternatives to petroleum Mechanical, physical, and chemical properties from additives Degradation from light, heat or bacteria

Melt flow Color specification and

fade

Flame retardancy

Surface appearance Tack/friction Incorporation of

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Preparing an R&D Credit Claim

With the opportunity available and being claimed by other manufacturers, why isn’t the plastics and rubber industry maximizing their return?

1. Too much effort

One reason may be that the industry is busy innovating! A common complaint among companies claiming the credit is that it monopolizes employee time and requires endless amounts of documentation.

Capturing the credit properly, requires a cross functional team of finance and engineering skills, with the right access to legal and tax expertise. That team needs a clear

implementation plan that minimizes the hours from the valued technical resources. Furthermore, interviews to determine the qualifying activities should be conducted by engineers or scientists who understand the industry language, so that time is minimized. The interviews should be discussing the activities rather than having to explain the process of polymerization.

2. Fear of Audit

Another reason may be the fear of audit, which is not unwarranted. The R&D credit used to be a Tier I Issue, which often resulted in lengthy audits. However, the IRS removed that designation in 2012 in part due to taxpayer favorable court decisions clarifying the documentation requirements.

Nonetheless, an audit is always a possibility. The claim must be prepared with an audit plan in mind. However, with the proper documentation and support, it does not have to be a painful process. Readily available documentation is used to support technical reports, which are created to illustrate your product development lifecycle and provide compelling examples of projects with activities linked to the qualifying 4-part test.

References

1. “Domestic R&D paid for by the company and others by industry and company size." Business Research and Development and Innovation: 2011. National Science Foundation, 30 December 2014. Web. 27 January 2015. <http://www.nsf.gov/statistics/2015/nsf15307/#chp2>. 2. "U.S. patent applications and patents issued for companies with and without R&D activity, by industry and company size." Business

Research and Development and Innovation: 2011. National Science Foundation, 30 December 2014. Web. 27 January 2015. <http://www.nsf.gov/statistics/2015/nsf15307/#chp2>.

3. "Table 1: Corporations Claiming a Credit, by Industrial Sector 2011." SOI Tax Stats - Corporation ResearchCredit. Internal Revenue Service. Web. 27 January 2015. <http://www.irs.gov/uac/SOI-Tax-Stats-Corporation-Research-Credit>.

4. "Table 2: Corporations Claiming a Credit, by Manufacturing Subsector 2011." SOI Tax Stats - Corporation Research Credit. Internal Revenue Service. Web. 27 January 2015. <http://www.irs.gov/uac/SOI-Tax-Stats-Corporation-Research-Credit>.

5. "U.S., all industries." Historical Data Tables by Enterprise Size - 2011. United States Census Bureau, 1 December 2013. Web. 27 January 2015. <http://www.census.gov//econ/susb/data/susb2011.html>.

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About Tax Credit Co:

Tax Credit Co. provides tax incentive consulting, administration and technology for small business to Fortune 100 companies. Since 1996, Tax Credit Co. has been helping clients increase earnings by optimizing the process of obtaining a broad range of state and federal tax incentives. Tax Credit Co. provides complimentary assessments of credit value, and works closely with you and your team to maximize credits and deductions, with reduced audit risk.

Team with Industry Experience. Our team is comprised of individuals with specialized technical expertise – tax attorneys review third-party contracts, relevant industry experts conduct interviews, and CPAs with R&D credit specialization review each calculation and tax return.

Innovative Solutions to High Value Problems. There is the easy way and the best way, which are not always the same. Tax Credit Co. works to ensure the best result for your business. This includes digging through boxes to find old records. But it can also include complex technical work such as obtaining a Pre Filing Agreement (“PFA”) with the IRS to have your methodology and credit amount pre-approved prior to filing your return.

Aligned Interests. Whereas many firms charge for this phase, Tax Credit Co. provides a complimentary assessment (Phase I) to determine your estimated benefit and utilization. TCC also offers flexible fee arrangements that allow us to structure fees including audit defense services to better align interests.

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About the Authors

Kim Hopkins, Ph.D. is Vice President of Strategic Accounts at Tax Credit Co. Kim works closely with Tax Credit Co.’s service line leaders to bring

comprehensive and customized tax incentive solutions to TCC’s current and prospective clients. Kim received her Ph.D. in Mathematics with a focus in computer algorithms from the University of Texas at Austin, and was a National Science Foundation postdoctoral fellow at UCLA prior to joining Tax Credit Co.

Peter Mehta, J.D., LLM is Managing Director of R&D Credits at Tax Credit Co. Peter has 20 years of experience with the Big 4, including 12 years with Deloitte in Tax Controversy where he worked in a national group of 5 attorneys supporting clients’ R&D audit defense needs. Peter has extensive R&D credit study and audit experience with IRS specialists at Exam and Appeals, as well as with MITRE on software audits. Peter has a B.S. in Biology with a specialization in Chemistry from UC Irvine.

Chris Petros, M.S. is the lead Manager of R&D Credits at Tax Credit Co. Chris joined Tax Credit Co. as a subject matter expert after spending four years as a project manager at Northrop Grumman Aerospace in

manufacturing, lean processes, production and design. Chris received his B.S. in Aerospace Engineering with a minor in Mathematics from UCSD and his M.S. in Systems Engineering from UCLA.