LOGISTICS
Making Innovation Pay
Research and Development Credits for Consumer and Industrial Product Innovators By Michael Sacco, Managing Director, National Consumer and Industrial Products Industry Leader, CBIZ CPAs
Consumer and industrial product (C&IP) companies operate at the intersection of engineering, software and advanced manufacturing. Their ongoing innovation across appliances, electronics, automotive, aerospace and defense makes the federal research and development or research and experimentation (R&D or R&E) credit a highly effective cash-flow tool. At its core, the federal credit reduces income tax dollarfordollar as part of the general business credit. Eligible small businesses may also use it against the alternative minimum tax, and qualified startups can apply up to $500,000 per year against the employer portion of Social Security tax, subject to the statute’s thresholds and definitions. If you can’t use the entire amount in the current year, the credit generally carries back one year and forward up to 20 years. Many states layer on their own R&D credits, some of which are refundable or transferable, thereby substantially increasing the total benefit.
after Dec. 31, 2024, or spread evenly over 2025 and 2026. Foreign R&E would remain on a 15year amortization schedule. Some states have decoupled from these federal changes, so state rules may still require capitalization. Section 174 (deductions) and Section 41 (credits) serve different purposes. Both are typically available, but you should carefully consider whether to take a smaller credit to preserve your deduction. Qualifying Work: The 4-Part Test To claim the credit, your activities should meet all four criteria: •
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Section 174, Section 41 and Cash Flow The Tax Cuts and Jobs Act (TCJA) required capitalizing and amortizing research costs starting in 2022—five years for domestic R&D and 15 years for foreign R&D—raising taxable income for many innovators. The One Big Beautiful Bill Act (OBBBA), enacted in 2025, allows an immediate deduction, elective capitalization over at least 60 months, or a separate optional 10-year write-off for domestic R&E for tax years beginning after Dec. 31, 2024. It also lets taxpayers deduct unamortized domestic R&D from 2022 to 2024 either all at once in the first tax year beginning 38 | FM
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Permitted purpose: You aim to develop or improve a business component (product, process, software, formula or technique) in function, performance, reliability or quality. Technological in nature: The work must involve science or engineering, rather than marketing or aesthetics. Elimination of uncertainty: At the outset, there was technical uncertainty about the optimal design or method for achieving the objectives of the development effort. Process of experimentation: You evaluated alternatives, tested different approaches and refined solutions to resolve the uncertainties.
What R&D Looks Like in C&IP Qualifying work often includes iterative product development to enhance performance, durability, energy efficiency or safety. Process engineering may improve yield, throughput,
quality or automation. Pilot builds and prototypes are created for learning rather than routine production. Teams frequently develop embedded software and control algorithms and integrate robotics and machine vision to address automation challenges. Testing new materials, coatings and formulations, including lightweighting, is common. Simulation and digital twins support optimal design development. Verification and validation activities that address technical uncertainties generally qualify, whereas routine quality control does not. Certain activities are generally excluded from the credit. These include: • • • •
Work performed after commercial production is established, unless new technical uncertainties emerge Cosmetic updates or market-driven styling Adapting an existing product to a single customer’s needs without genuine technical uncertainty Duplicating a competitor’s product
Funded research may be disqualified if you lack substantial rights in the results and do not bear financial risk. For federal credit purposes, research conducted outside the United States is not eligible for Section 41, though some foreign costs may fall under Section 174. Which Costs Count—and Which Don’t Qualified research expenses are central to the credit calculation. W-2 wages for employees who directly perform, supervise or support qualifying activities are eligible. Supplies consumed in qualified research, including materials for noncapitalized prototypes, are mannpublications.com