R&D Tax Credit Case Study: Machine Shop

Every custom manufacturing project begins with a technical challenge. One customer needs a stainless-steel component held within thousandths of an inch. Another requires a custom fixture just to machine the part without distortion. While every project is different, they all require engineers and machinists to answer the same question: “How do we actually make this?”

A Pennsylvania machine shop – Company MS – manufactures custom precision components for customers in a variety of industries.

Because each component has unique material requirements, tolerances, geometries, and performance expectations, the company regularly develops new machining methods, custom fixtures, CNC programs, and manufacturing processes to successfully produce parts that have never been made before.

Like many machine shops, the company assumed the R&D Tax Credit was reserved for laboratories or large engineering firms. After working with the Walz Group, they discovered that much of the technical problem-solving taking place on the shop floor qualifies for the Credit.

Eligibility
The consulting team worked closely with Company MS to evaluate its activities using the IRS’ Four-Part Test.
In order to qualify for the Credit, a company’s activities must pass all 4 parts of the Test.

1. Activities relate to creating or improving a product or process
Each customer project required Company MS to develop new precision-machined components and/or improve the manufacturing process used to produce them.
Examples included:
• Developing machining strategies for complex stainless steel and aluminum components
• Designing custom fixtures and soft jaws to securely hold irregular parts
• Creating new CNC machining programs and manufacturing sequences
• Evaluating heat treatment and grinding sequences to eliminate dimensional variation
• Comparing waterjet cutting, conventional machining, and other methods to determine most effective fabrication methodology
• Improving production methods to achieve tighter tolerances and better repeatability
Part 1: Company MS creates or improves products and processes daily – passed.

2. Activities are undertaken to eliminate uncertainty
At the beginning of many projects, the team simply didn’t know the best way to manufacture the component.
Questions included:
• Which machining sequence would maintain dimensional accuracy?
• How could the part be securely held without distortion?
• Which cutting tools, feeds, and speeds would work best for the material?
• How could critical tolerances be achieved consistently?
• What manufacturing method would produce the required fit and finish?
These technical uncertainties had to be resolved before production could move forward, and the manufacturing process itself is often the innovation.
Part 2: Seeking answers to these types of questions is at the heart of all Company MS’ activities – passed.

3. Activities involve experimentation (evaluating alternatives, testing hypotheses, modeling, trial and error)
Rather than relying on a single approach, machinists and programmers evaluated multiple alternatives throughout development.
Typical activities included:
• Testing different tooling and cutting parameters
• Comparing machining sequences
• Refining CNC programs
• Designing and modifying custom workholding fixtures
• Measuring results and adjusting the process until specifications were met
Part 3: This systematic trial-and-error process is exactly the type of experimentation contemplated by the IRS – passed.

4. Activities are technological in nature
Company MS’ work relied heavily on principles of:
• Mechanical engineering
• Manufacturing engineering
• Materials science
• CNC programming
• CAD modeling
• Precision inspection techniques
Part 4: Because Company MS’ activities relied on engineering and manufacturing principles to solve technical challenges, they satisfied the technological requirement – Passed.
Four tests, four passes – Company MS’ activities qualified for the R&D Tax Credit.

Costs
After confirming eligibility, the consulting group evaluated the costs associated with the qualified research activities.
For this company, the primary qualifying expenses were employee wages.
Wages
Many machine shop owners are surprised to learn that qualifying wages extend beyond engineers. Engineers’ wages qualify of course, but so do the wages of those supporting research — technicians, machinists, fabricators, etc. – and those supervising it – project managers, plant operators, etc.
If an employee spends more than 80% of their time on qualified research, 100% of their wages can be counted towards the Credit. If they only spend a fraction of their time on qualified research, only a commensurate fraction of their wages can be counted towards the Credit.

Eligible employees at Company MS included:
• CNC programmers
• Machinists
• Manufacturing engineers
• Project supervisors
• Fabricators, technicians, drafters
The consulting team carefully reviewed employee responsibilities, interviewed key personnel, and analyzed supporting documentation to determine the appropriate qualified wage percentages.
Total payroll: $493,000
Qualified wages: $428,000

Study Process and Documentation
A successful R&D Credit depends on more than simply identifying qualifying projects – proper documentation is crucial, and it must clearly tie expenses to specific qualifying activities.
The consulting team reviewed available supporting information, including:
• Customer drawings
• CAD models
• CNC programs
• Inspection reports
• Manufacturing documentation
• Payroll records
They also interviewed multiple team members at Company MS for further information on projects, roles, and activities.
This information was organized into a comprehensive report documenting both the technical activities performed and the associated qualified expenses.
All calculations and technical analysis were completed by experienced professionals.

Outcome
The study results were as follows:

Benefit Amount
Federal R&D Tax Credit $33,000
Pennsylvania R&D Tax Credit $17,361
Total Tax Benefit $50,361

Keep in mind, the R&D Tax Credit is a direct dollar-for-dollar reduction in tax owed. With approximately ten employees and annual payroll of roughly $493,000, a $50,000 Credit represents a meaningful source of additional capital that can be reinvested into equipment, technology, and future manufacturing innovation.