Paul Van Metre:
Good morning, everyone. Good morning and thank you for joining us today for a timely and very important webinar topic. I see some names that I know here in the attendee list. Morning, Alex, and Alex, and Bo, and David, and Jay, and Joseph and Killian, and Mary, and Steve, and Tom. Awesome. Well, as for those of you that have attended at least one of our webinars, if not more, you’ll know that I would love to have you put in the chat where you are coming from, which city or town or country or wherever, and we’ll see where we have everyone joining from.

Justin Quinn starts us out in the Q&A, which actually thank you, Justin, appreciate it. So some housekeeping. Yes, the chat is great for reactions and sharing excitement or whatever. The Q&A is where we want to put questions because they tend to get lost in the chat. So if you do have a question, we will definitely have an area for Q&A at the end, both for us and for Moss Adams. So please use the Q&A for that, but yes, I can see we have a wide variety of people from all over the place. Mount Vernon, Nashville, Tennessee, California, Illinois, Denver, Michigan. Fantastic. Thanks, Rodie, and there’s Kurt from Houma, Louisiana. Good to see you here, Kurt. Frank from Oklahoma, awesome.

So all right, well, we have again, super important topic today. It’s striking to me how few shops understand the R&D tax credit, realize which activities they actually do all the time that qualify for the R&D tax credit. It’s not just for scientists, it’s not just for software companies. So we’re going to dig in today and we are very blessed to have Moss Adams, both Vanessa and Amanda. So let’s get in and we’ll do the intros and knock this one out.

Always love to start our webinars with a mission statement. We deliver powerful manufacturing software by deeply understanding our clients’ challenges in order to meaningfully improve their businesses and in turn, their communities. We hope that today we can provide a little bit towards that mission by helping you guys figure out how to save some tax money, which can always go to growing the bottom line.

My name is Paul, I’m one of the Co-founders of ProShop, and I’d love to introduce the panel here. Let’s start with you, Vanessa.

Vanessa Oviatt:
Yes, hi everyone. I’m really happy to be here today. So my name is Vanessa Oviatt. I’m a senior manager in our R&D tax practice, I’m based in Seattle. I have about, oh, I think going on 13, 14 years of experience with the R&D tax credit at this point. I mostly focus on the aerospace industry, but again, broader with the manufacturing or advanced manufacturing. That’s a little bit about my background.

Paul Van Metre:
Awesome, and Amanda?

Amanda Arnold:
Hi there, good morning. So happy to be here and get to speak in front of everybody. My name’s Amanda Arnold, I am a manager at Moss Adams and focusing on research and development tax credits. I live in the Spokane, Washington area and have about going on 10 years of experience. I work alongside with Vanessa too, so both of us are in the manufacturing aerospace industry. So excited to be here.

Paul Van Metre:
Awesome, and Mr. Mike?

Mike Payne:
Paul, thanks for having me. Mike Payne with Hill Manufacturing in the Tulsa, Oklahoma area. So I have a background back 20 years ago maybe starting to deal with R&D tax credits when I was with a large national regional CPA firm. Since that time have bought a few CNC shops and use R&D tax credits ourselves.

Paul Van Metre:
Could not imagine a better co-host to have this with expertise on both sides. So awesome, Mike, thanks for joining us.

Mike Payne:
From my time at a CPA firm, I’m going to tell you that I’m not an expert.

Paul Van Metre:
All right.

Mike Payne:
As the Moss Adams folks can attest to.

Paul Van Metre:
Sure. Well, you’re the shop expert side of the business.

Mike Payne:
Okay, I’ll claim that one.

Paul Van Metre:
So yeah, here’s the agenda today. Vanessa is going to go over the overview of the R&D tax credits and claiming it. I’m going to cover how ProShop can help with the data collection and reporting. Then Mike will talk about some of his experience. Then Amanda’s going to go over this section 174, which is also something that’s very important to understand and probably just like R&D, not nearly enough people do. So we’ll be, and then we’ll get into Q&A after that. So, let’s dig in here. You want to take us away, Vanessa?

Vanessa Oviatt:
Yeah, thank you. Yeah, so I’ll just give a quick overview of what the R&D tax credit is. So I think the most important thing to know is that it is a dollar-for-dollar tax savings and it directly reduces a company’s tax liability, so it’s a very beneficial credit to have. It’s going to be based on the US activities only, so it is a federal credit. Now, I’ll talk a little bit about potential state credits that can also apply here for the R&D tax credit, but we’re mostly going to be talking about US activities, foreign research activities are typically not eligible.

So there really is no limitation on the amount of expenses that you can have or the amount of credit that you can claim each year. It’s really going to be about, what are you spending. We’ll go into a little bit about the different types of expenses in a minute, but just all the expenditures that are related to any kind of R&D activity could potentially qualify.

So when you’re claiming a federal credit, if for some reason you’re not able to offset your tax liability in that current year, or even if you can, you can go back a year, but you can also carry it forward for 20 years. So the credit is once you’ve claimed it’s yours for the next 20 years until you can utilize it. So if you think you’re going to be having to pay taxes and in that taxable income position, then the credit could be beneficial.

We can also go back to the three prior years to amend for a company to claim the credit. So the last three years are open for the statute of limitations, and so you can go back, amend, but we’ve also had clients who said, hey, we’ve been around for 10 years, 20 years. I want to go and claim this credit and I want to build up that carry forward because I’m going to be able to use it now. So I’ve done a decade’s worth of credits before of doing that whole study. So there are options for you, but typically the last three years are going to be open and you could go back and amend. That’s an easier way to claim those credits.

Paul Van Metre:
So if someone learns something today and they’re like, holy smokes, we’ve been doing that for years now, they potentially could go back and get some money back.

Vanessa Oviatt:
Exactly, exactly.

Paul Van Metre:
Awesome. Well pay attention to everybody, here we go.

Vanessa Oviatt:
Yeah, so this goes over what the eligibility is. So we call it our four-part test. The first is going to be, there needs to be a permitted purpose. So it just means that you’re developing something new, or it could be you’re improving a current product or process. So that’s really the key where I think a lot of people don’t realize that they could still be claiming credits, because just because you have a product out there, if you’re still adding features to it or making significant improvements, or maybe it’s a different application of that product that’s out in the market, you could potentially claim an R&D credit on those expenses.

So the next is that it needs to be technological in nature. That’s usually the easy test because it just has to be based on a hard science like engineering. Then technical uncertainty, so this is the big one. What activities are you undertaking to discover that information? What do you need to do to eliminate that uncertainty. You have an idea of what you want to accomplish, but you don’t know how you’re going to get there. All the things that you’re going to be doing, all the testing you’re going to be doing is really going to be related to, how am I going to eliminate that uncertainty and what are the alternatives to be considered?

That ties into the fourth piece here, which is the process of experimentation. You are evaluating those alternatives in order to see if you’re getting that result that you want. I think the key here is to, what kind of testing are you doing? Are you doing modeling, are you doing simulations? Are you actually doing a systematic trial and error process that can be documented? Those parts three and four really tied closely and are the most important piece about what we need to document for purposes of claiming the credit.

Paul Van Metre:
All right, so if I could bring that to this audience, starting with number one, improving a process and resulting in increased performance. So that could be optimization of a CNC program, that could be new fixturing, that could be potentially new cutting tools. Does that sound all like things that might apply, Vanessa?

Vanessa Oviatt:
Yes.

Paul Van Metre:
All right. So in the chat, I’m going to ask the audience in the chat, put in the chat, do you do setups where you’re trying to figure out your G code, you’re trying a new fixture, you have a brand new cutter you’ve never tried, a new tool path? Just say yes in the chat if that is something that you do, because I know every shop pretty much does these things every single day, whether it’s a brand new part number, whether it’s an existing part number, that you realize maybe you did some prototypes and now you need to see the chats lighten up. It happens all the time, but a lot of shops don’t realize this is R&D. So thank you Vanessa for that, I know that’s resonating with people and we’ll talk a little bit more when we get to our slides on that. So yeah, let’s get into the rest of it.

Vanessa Oviatt:
Yeah, so there’s typically four areas of potential research expenses that we’re looking at. The first and most of the time, the biggest one, is going to be wages, so your employee wages. Any employee that qualifies for the credit, we’re going to be looking at their form W2, their box one taxable wage. One thing to note here for flow throughs, potentially some of that pass through income that could be subject to self-employment tax could also be eligible, that piece of it. Essentially, we’re looking at individuals that are performing R&D activities. They could be directly supporting that activity or even supervising that activity. We’re going to be able to take their wages, a percentage of their wage, and if the majority of their time, more than 80% of their time is spent on those R&D activities, there’s a gross up rule where you could take 100% of their wages. So if they meet that 80% threshold, we could take 100% of that wage, so potentially that employee’s entire wage could qualify for the credit. So that’s the biggest one there.

One that may or may not apply to some businesses here is going to be computer leasing. This is where if maybe there’s a software component to maybe what you do, cloud storage expenses for hosting can qualify, so if you’re doing development on the cloud. The third area, which is probably going to be the other biggest ones that I’ve seen in the manufacturing space is going to be supplies. This could be supplies or materials that are used or consumed during your qualified research activity. Another way to put it would be, are you building prototypes? If you’re building prototypes or doing first article runs, those are going to be the types of expenses that we’re looking at and are most likely to qualify for the credit, but it can even be every day. Maybe there’s small tools that are being consumed during the research, we could potentially pick that up as well.

Then the last piece is going to be contractors. So any of those third-party vendors, maybe they’re helping you with some of your testing. As long as they’re performing that testing in the United States, we can pick them up. They are subject to a haircut, so we can only pick them up at 65%, but there’s still expenses for anybody that you’re paying out there to help you with that development. We could potentially pick that up as well.

Paul Van Metre:
So there’s a timely question in the Q&A, which we might as well just handle now. So from Mary, if we hire someone as a 1099, can the expense we pay them be qualified under this?

Vanessa Oviatt:
Yes, potentially yes. So yeah, we’re talking about 1099s as well.

Paul Van Metre:
Okay, very good. So if they’re participating in those activities that qualify, even if they’re a 1099, but so let’s say an employee is a 100% doing R&D, let’s say they’re a prototype machinist. If you had a contractor doing the same thing, you could only get 65% of their costs that the company’s incurring?

Vanessa Oviatt:
Correct, yes, that’s correct. It’s just one of those rules for contractors, you have to have that haircut, but yes, that’s right.

Paul Van Metre:
Okay. Might as well get to this one as well. If the material is supplied by the customer, does that make credits ineligible?

Vanessa Oviatt:
Yeah, that is a little bit different depending on, there is this layer of, is there funded research involved? So a lot of the time if they’re basically supplying it or they’re paying for it, you’re not incurring that expense so you wouldn’t be able to take a credit on it. We don’t go, it’s a little bit more in depth, but if you have IP rates to the research, do you have financial risk in the research being performed? So there’s a difference between that internal R&D where it’s the company’s cost that’s being incurred. That’s usually the easy ones to look at, in terms of expenses. Once you start dealing with contracts with your customers, there’s another layer involved there that we would have to look into on whether we could potentially pick up those expenses. So that’s what I’ll say about that, so there’s the internal R&D part and then there’s the R&D that may be related to a customer.

Paul Van Metre:
Got it. So it sounds like if they’re providing the material, very likely that wouldn’t, but the labor used to apply to that material would still all count?

Vanessa Oviatt:
Yeah. Yes, potentially, yes.

Paul Van Metre:
Okay, right on. Very good. All right, let’s move on here.

Vanessa Oviatt:
Yeah, so this is just a list of different types of activities that I’ve seen or potentially qualify. The biggest one I see is really with designing or testing prototypes and pilot models. I think that’s really where a lot of companies don’t realize that they can claim an R&D credit on those expenses and typically, they’re very large expenses that the company is incurring. That’s the biggest one that I have here and put it as number one.

But of course, anything that you’re doing, whether you’re developing a new technology, it could even be software to improve the manufacturing process, that’s going to qualify custom equipment, whether that’s something that’s being done in house or it’s something that you’re paying a third party for. A lot of that design time could qualify and potentially even some of the cost of that new equipment. That gets into a little bit more of a gray area, but we look at those contracts for what is involved there for that custom equipment, but something that a lot of people don’t realize can also qualify. Anything you’re doing to test alternative materials, just improve the product’s performance during the manufacturing process can qualify. We just wanted to lay out some potential areas of different types of activities that could potentially be eligible. Happy to answer more questions later on as well on that.

Paul Van Metre:
Yeah, great. So yeah, I see some more coming in, but we’ll hold those until a little bit later. Yeah, let’s get into actually doing the claiming part of it.

Vanessa Oviatt:
Yeah, so when you’re claiming the credit, it’s going to be on your federal tax return. There is a form called 6765, which is the one where you claim the credit. It’s going to be when you’re filing your return, so whether that’s on time or during an extension, as long as it’s on an original and timely return, that’s where you’re going to be able to get the benefit right away for any taxes that you may have to pay for the current year.

There’s essentially two methods that can be utilized to claim the credit. One is going to be where you’re looking at your gross receipts. You have to look to the past four years of your gross receipts and also looking to see when was the first year you started that. So there’s a complex calculation that goes on there to calculate what that would be, but that’s one method.

The second is going to be, and this one’s usually the one that I typically see for someone who’s been around for a while but hasn’t claimed a credit, is you’re going to look to the three prior years. You’re actually looking at the qualified research expenditures, not only for the current year, for the three prior years. That really has to do with just the mechanics of the calculation. You have to establish a base threshold for your current year credit. Regardless if you want to go back and claim prior credits or not, you are going to have to look back and gather expenses at the very least for the three prior years, including the current year. I always make sure that when I’m talking to prospective clients, that they’re aware of the type of information that they’re going to have to pull to be able to do that. Of course, if you’re claiming for on an amended return, there’s some other steps required for that, in terms of documentation, but still a possibility there.

One thing I do want to mention here which is important, if you’re a new business and you’ve been around for less than five years or have had gross receipts for five years or less, and you also have less than $5 million in gross receipts, you could potentially qualify for this payroll credit. So this is a special election that you can make when you file your federal tax return. Right now for 2023, they actually increased the credit so now you can get up to $500,000 that can be elected to offset your payroll taxes. That’s going to be your social security or FICA tax, as well as your Medicare tax. Don’t know what the base here is for who could qualify for that, but definitely something important to mention if you’re a newer business starting up.

Paul Van Metre:
I do know that we have some of those in the audience and that are doing just intensive prototyping and R&D and things like that on behalf of their clients, so very likely possible. I have a question on… Going the three-year prior research. Let’s say there’s a shop that’s been in business for 10 years and they’ve never done this before and they have decent but not impeccable records of time tracking and things like that. How would you advise them to look back at how to quantify once they understand the categories and what kind of activities qualify? Yeah, how would you advise on that?

Vanessa Oviatt:
Yeah, so typically we’re going to be for the expenditures, at the very least, we’re going to be looking at GL detail, so vendor level GL detail the majority of the time. Hopefully in terms of those records for those expenses would be easier to pull. When we’re talking about employees, I think that’s where it gets a little trickier if there isn’t any time tracking involved, but you are allowed to use estimates. It’s maybe a little bit more of an involved process while you work with your provider, but you’re able to gather those employee wages and you go through a process to estimate what that time could be that they were involved in the R&D activity. So it is a bit of a process to do, but it’s still doable and something that shouldn’t deter anybody from going after those credits.

Paul Van Metre:
Got it, okay. So let me just dig a little deeper yet. So let’s say someone did a job and it was a $10,000 job and they know from their estimating process that they figured it was going to take 50 hours of labor and then a bunch of material as well. If that job came in, call it at about the profit margin they calculated, probably reasonable expectation that it actually did take them about 50 hours worth of labor. Is that the kind of research that they might then be able to extrapolate and say, even if they didn’t have a time ticket or a time tracking for that?

Vanessa Oviatt:
Yeah, you definitely use a reasonable method such as that to be able to figure out an employee’s time spent on the project. You will say that it is at the employee level and how many projects they were involved with during the year. Yeah, but just the percentage of their time spent on R&D for the entire year is what we’re looking at, but that would be a reasonable way to do it.

Paul Van Metre:
Okay. Well I’ll get on my high horse, people. I keep telling you about the importance of time tracking it is just so important for so many things and here’s another reason why it really needs to be a solid part of your company’s process.

Vanessa Oviatt:
Yeah, so I’ll talk a little bit about the documentation piece. There’s going to be, we categorize it into quantitative and qualitative documentation. So the quantitative part is a lot of what we’ve been talking about. You get your form, W2 box one wages, your general ledger details, any time tracking that may be involved there. We have that list of projects or jobs that may have been worked on. Of course, ProShop is a way to be able to track that time. I know Paul will go into it a little bit further, but for the qualitative aspect of this, there’s also going to be, what are your projects and providing a project description. Then what kind of repository do you have for any design revisions? Do you have test logs and reports? What kind of notes do you have that you can potentially save as documentation? So there’s a lot of document gathering that happens, but we also go through and talk to your subject matter experts and put together the narrative of what types of activities were involved in a particular project, what kind of alternatives were considered, and what kind of testing was done, and what was the end result of all of that research.

Of course not everything happens in one year, you go through various phases, so it doesn’t have to be complete in the year when we’re talking about it. As long as there’s research activities going on, we can document that, but the documentation piece is something that the IRS really hones in on and has been cracking down on particularly over the last several years as we’ve seen. So the documentation is so, so important for claiming the credit.

Paul Van Metre:
Got it, got it. That project description and plan in a shop’s talk, is that basically like a work order? So they have a prototype work order, that’s what tracks the activity through the shop? Is that the project description plan?

Vanessa Oviatt:
Yeah, so it’s going to be a little bit more of, what talking through, tell me a little bit more about your project. What were you trying to achieve, what were your goals, what challenges did you face? So it’s a little bit more of a narrative, which we usually get by having interviews with some subject matter experts at the company to get through those details. The work order itself is valuable for other documentation purposes, but that’s what we’re getting at with the project description.

Paul Van Metre:
Got it, okay. Thank you very much. Let’s move on to talk about how ProShop can help. So first of all, as Vanessa shared with us, there are a lot of activities that are everyday common things that machinists and programmers and planners and people are doing out in the shop or in the office that do qualify for this. Just hopefully the education part of this webinar of just understanding what actually does qualify, is the foundation of then putting a process in place to be able to record it and then relatively easily file for that.

So two things here we talk about, and these are obviously screenshots out of ProShop. So we’ve honed in on these two fields that we have. One is called work order type and the other is work order class. Work order type has a number of different options and clients can even make their own options, but this one that we have highlighted here, first run, new rev. So there’s two options for this, if you get a brand new part number that you’ve never made before, the first time you run that job, you’d classify it as a first run new rev. Obviously it is a new revision by default that you’ve never done it before. So for sure, the programming time, the making fixtures, the proving out the program, correct me if I’m wrong, Vanessa, but those activities highly likely that would qualify. What about the actual production? Let’s say in this case we’re trying to make 15 pieces, the actual machining after your first article is done, the rest of the 14 of them, would that qualify?

Vanessa Oviatt:
Yeah, so typically no, there is a cutoff point for when you get to that production step. Usually with the R&D credit, once you’ve figured out what you need to do, you’re ready to get to that more volume of production. That’s usually the line of anything before all that can qualify, anything after that cannot, but definitely good to have that distinction.

Paul Van Metre:
What if you prove out your part, you start running and then you start having problems and you have to go back into several of the troubleshooting mode and figure out new tool paths or new cutters or new fixturing methods?

Vanessa Oviatt:
Yeah, so all of that, again, when you’re going back and having to make revisions, all of that time can qualify again.

Paul Van Metre:
Okay, fantastic. Well, you guys heard it from the expert, because I know many of you participate in those activities all day long. So yeah, the key in whatever system you’re using, make sure you have some method where you’re classifying it as a new job. Then really, that time tracking activity, and we’ll talk a little bit more about that in a moment. Then a work order class, that’s just another way to basically classify and then in the future run a report or a query of exactly which activities at least partially qualify, if not every hour of all the time tracking does. At least you’re much better off if you have a way to get that list of those types of work orders.

So here’s an example of a report or a query for an eligible job. So you can run that report from January until December 31st. What were the work orders that classify as that? You can see certainly their costs. We could certainly then run right here on the bottom. We have a really easy ability to take a list of work orders and then from that list run a time tracking report directly off of that query just with this little breakdown option. So that would give you another report showing all the time tracking activities for those specific set of work orders.

Then from that report you can then come in here and classify the programming, the troubleshooting, the inspection, first article, the setup, everything that’s basically not running or possibly breaking down the job. To probably strengthen that if you did have the IRS come in for an audit, would be to have notes. It doesn’t take more than a minute or two to add some context to that time tracking event. Continuing the setup, broke a tool, making a fixture, troubleshooting the program, figuring out my feeds and speeds, whatever. Those are all things that are still where there’s uncertainty, you’re improving the process, and I think would solidly qualify for that activity.

Then there’s this other concept of, and Vanessa, I’d love your thoughts on this. We had this slide from the last time we did this webinar with you guys. When you’re doing research on something. This is an example of, we made this little work order where we need to buy a new machine, it’s not like one we have in the past, so we need to do research, we need to maybe do a trade show. In this case we made a work order type for research and reclassified it as that. Then tracking time and expenses. So how much or what of that kind of activity might qualify?

Vanessa Oviatt:
Sure, yeah, so I would say any kind of research around the requirements that you need, maybe alternative materials that you’re considering, any of that research leading up to that and that planning process could qualify. I would say that even up to the, of course once you get to the machining part, does something not work and maybe you have to do some more research to consider other alternatives. So people’s time and any expenses related to that can qualify.

For trade shows, I would say that the actual attendance or travel to the trade show typically does not qualify, but if you’re doing any work to build that mock-up, that prototype for a trade show, any of the time can qualify. It’s just the actual attendance itself, typically not in that travel time.

Then of course if there’s any other reporting that needs to be done for the findings, if it’s done concurrently with the work, a lot of the time that can’t qualify, but I would say if everything’s done, because we get a lot of technical writers a lot of the time for manuals, most of the time that won’t qualify once it’s after the fact. But if it’s anything that’s being done concurrently to figure out those documentation findings, then yes, but there is a little bit of a gray area there.

Paul Van Metre:
Okay, all right. Thank you for that. There are tons of questions, which is awesome. I’ve been reading them, there’s some really good ones and we’ll get to those at the end.

Just a couple takeaways for everyone here. Understand what the qualifying expenses are for, definitely build a system for tracking those costs. Talk to your employees about this, if they know which activities they’re performing are R&D and if they leave notes and track their time better, it’s good for the company, it’s good for them. Then yeah, just execute on it, collect it, do the work. So hopefully, regardless of whatever system you’re using, that is something you can take away.

Mike, I’d love to bring you in now with your background in the tax side where you were helping firms like the ones on this webinar, and now being in that seat yourself. I’d love to have your thoughts on everything you’ve been hearing today.

Mike Payne:
So just based on what I’ve heard today, let me reiterate what I said at the beginning. I’m not an expert because even though I’ve worked in it, I’ve learned a bunch this morning. I think first of all, so from my experience when I was helping to provide this service, a lot of people say, oh, we don’t do R&D and I’m sure Vanessa and Amanda can probably attest to that. There’s not an R&D line item on my P&L that I do R&D because we think of lab coats and a lot of really fancy work, but machine shops do a ton of R&D. We’ve found… So I mean even what I’ve seen today, even though I’m taking advantage of some of that and utilizing this credit, I’m already seeing ways that I’m leaving a lot on the table still. So if you’re not doing it, you’re definitely leaving lots of credits on the table, and even if you are, you might be.

Paul, some of what you went through there of how to track some of it, is not necessarily how we’re doing it. For example, when we have a new prototype job, we need to create fixtures. So we have work orders for those fixtures, so I’m capturing that time, definitely capturing programming and so forth, but I think there’s a lot more work. Some of the setup on those work orders, but there’s still a lot. We haven’t had the floor tracking, troubleshooting and so forth necessarily separate from running where they had to stop and start over. So there’s a lot left on the table there.

I’ll couple that, a couple other points I’ll make too, if I don’t know how many people maybe on the call or maybe in a similar boat to me where we’ve bought some additional businesses over the last few years. When we bought the stock, not the assets, and they haven’t been taking advantage of R&D credits, since this has that historical nature and you can refile for three years, we’ve been going back and recapturing some of that that we can track, that helps offset the price we’re paying for that company. So if anybody’s in that boat, look at that.

Also, if you are getting ready to maybe sell your company, which I know there’s probably somebody on the call that’s thinking about that, get a hold of that now because once you’ve sold it, you might not get to recapture some of those credits and it can offset your gain you’re going to have on selling the business.

The other thing I’ll point out too is, Paul, and I know you and I talked about this two weeks ago. We’ve been very fortunate and the state of Oklahoma has several grant dollars available for growth and developing new processes, retaining jobs, creating jobs, so forth. We’ve been very, very active in some of those things. The same processes we’re talking about here have allowed us to track and gather some of those same grant dollars.

I mean, I’ll just say thank you to ProShop for giving us the ability to track this because I know from my history in this, it’s almost impossible to track if you’re not doing it as you go. ProShop gives us the ability, even passively to capture some of this information where we’re not necessarily… I love the way the examples you gave where you are specifically tracking it to R&D credits. We are not doing that. We need to be because there’s a lot of opportunities we’re leaving on the table. But I would just advise everybody to explore this, talk with your accountants, talk with Moss Adams, whoever. I mean, there’s a real opportunity here to make some significant… And this all goes straight to your bottom line. I mean it’s significant to the company.

Paul Van Metre:
Yeah, and the last time we did this, we had a different shared client on the webinar with us and I think they shared, they had historically not understood it, not did it. Then when they started doing it, they were taking an extra $100,000 in a tax credit. [inaudible 00:37:50]-

Mike Payne:
Well, I think that’s what I shared with you a couple weeks ago, Paul. In the six years I’ve owned Hill and the entities we’ve bought since, between credits and grants and so forth, I mean we’re up over, we’re roughly three quarters of $1 million over six years with credits and grants. That’s real money.

Paul Van Metre:
Absolutely, that’s [inaudible 00:38:11].

Mike Payne:
That’s significant.

Paul Van Metre:
That’s new machines.

Mike Payne:
Absolutely.

Paul Van Metre:
Yeah, awesome. Well thank you, Mike. I really appreciate all your input on that.

Mike Payne:
Yeah, my pleasure.

Paul Van Metre:
We’re going to switch now and Amanda’s going to take the floor and talk about section 174, Amortization Overview, it’s a mouthful.

Amanda Arnold:
Yes, it is.

Paul Van Metre:
Take away, Amanda.

Amanda Arnold:
Thanks Paul. So this code section is essentially a broader view of research and of experimentation expenses compared to the already credit expense categories that Vanessa mentioned earlier in the webinar.

Historically, 174 research and experimentation expenses have been available to be deducted in the current year that they were incurred. Starting in January 1st, 2022, the Tax Cuts and Job Act made changes to disallow deductions for these expenses on the federal tax return. This modification now requires taxpayers to capitalize and amortize research and experimentation expenditures, and is allowing a small deduction of those expenses in the current year. So the remaining expenses will be available in incremental deductions over the next five years domestically and 15 years for foreign research. So that’s something to note, just as you’re looking at 174. Essentially, this is a timing difference for recognizing research deductions on your return. The impacts to companies who develop new or improved products or processes and who have previously claimed R&D credits could be substantial, just based on the nature of the deduction of those expenses.

Paul, I think you can move to the next slide, please.

Paul Van Metre:
Yeah, you bet.

Amanda Arnold:
Next I want to talk through just the impacts that this has on your business. 174 capitalization and amortization reduces the amount of expenses that can be deducted in the current year. So this ultimately results in a smaller expense deduction and ultimately creates an add-back to your income for the year. Each company has a different tax position in general, but higher income and less of a deduction available can potentially increase the amount of net income and taxes owed to the federal return in the current year. That’s definitely something to keep note of when you’re looking at 174.

For companies who are currently in a net operating loss position, an increase in income could create taxable income sooner than initially planned, so it’s really important to plan ahead for that too. As a result of 174, federal taxes owed maybe higher over the next five years, due to this timing difference for domestic and foreign expenses. We recommend discussing these 174 impacts with your tax provider to ensure there’s proper planning in place, especially when determining the estimated tax payments for the year and any impairments this could have to overall cash flow.

Lastly, I’d like to walk through the current legislation that is in motion regarding 174. The House and Means is a committee that basically talks through tax situations to help benefit taxpayers. Recently they met and proposed a bill to provide tax relief related to 174. In their meeting the vote passed, and so the bill moved on to Congress and Congress is now having a discussion related to this 174 issue and they’re actually meeting today about it and will vote later this evening. So we’ll have a good update hopefully later this evening. I wish we had one now, but we’ll take this evening, definitely.

So if the bill passes, 174 capitalization for domestic expenses will be delayed and will pick back up in 2026. We’ll have a little bit of reprieve now with the current 174 expense deduction, but we’ll have to look at this again in 2026. For federal expenses, it will continue to stay the same, so any federal or any foreign expenses will have to be capitalized, amortized for that 15 years regardless. Ultimately, this change will restore and bring back the ability to deduct all domestic expenses in the current year and will potentially be retroactive for 2022. We don’t necessarily know what those rules look like yet if it were to pass, but that is promising.

So after hearing this information, you may be wondering, what actions can you take to minimize the impact of 174 to your company, and the R&D credit may be a really good solution. I’m going to hand it back over to Vanessa so she can chat through how the benefits of the credit can help overcome 174.

Vanessa Oviatt:
Yeah, so we’re mentioning 174 because I’m sure a lot of companies from last year with their 2022 tax return experienced this, and then of course, going into 2023 until we know know more. But I want to say that the 174 impact is a compliance issue. So it’s something that needs to be done, whether you’re going to be claiming the R&D credit or not. So that add back to income is going to have effect on your business, if you have any research activities. The credit is going to help offset some of that, which is why it’s still important to go try to claim it because it’s going to help offset any of that tax liability that you’re now going to owe.

With 174, it encompasses R&D, so anything that is being claimed for the R&D credit will also be eligible for 174. That’s just how it works with that overlap. 174, there’s some broader items that need to be considered. Usually the amount is higher than what you’re claiming for the credit, but the credit in itself is still going to help offset some of that. Fortunately, not going to be able to offset the entire amount that you’re probably going to have to add back, but it’s still going to have an impact to reduce that tax liability you’re going to have to pay.

There is an overlap usually when we’re working with clients, we’re doing this work concurrently because we’re looking at very similar accounts for both. But just wanted to reiterate that this is one of those tax compliance issues where you are going to have to do 174 no matter what, but being able to do the credit will help offset some of that. So, it’s part of why we wanted to talk about it today, but again, we’ll see what happens a little bit later today and maybe it’s good news, but yeah, we’ll see.

Paul Van Metre:
Okay, yes, we tried to get Congress to go vote earlier than this webinar, but they just weren’t going for it, so we’ll have to wait.

Well, thank you for that, both Amanda and Vanessa. I know, I think that was really well explained. It’s still over my head on the 174, so definitely talk to your tax professional about it. For those that don’t have one or aren’t happy with theirs, we use Moss Adams back in the pro-CNC days when I ran my shop. We have a few shared clients today and they do an amazing job. I know that you guys had to share this slide, so this is just more a cover your butt kind of slide or what… Do you need to say anything about it?

Vanessa Oviatt:
Yeah, just everything we talk about here today of course is for informational purposes, do not use it as tax advice. Please consult your CPA, your tax professional, for anything related to the credit and again for 174. So that’s all I have to say about that.

Paul Van Metre:
All right, well we have almost 15 minutes for Q&A, which is good because we have a lot of them. So I’m just going to start here at the top. Thank you everyone that submitted them.

So Joseph asks, if there are industries such as space travel, that if you’re producing parts for it, that the whole industry is R&D, even if you’re only making parts or potentially having engineering design for manufacturability discussions with your customers.

Vanessa Oviatt:
Yeah, I would say that anytime that you’re talking about any kind of requirements for a potential new product, potential new process, especially in the space industry, yes, I would say that a lot of that time is going to qualify in that, I guess, what I would call that phase one. You’re trying to gather those requirements, trying to figure out that design of whatever it may be, so that time can qualify. Now, maybe you’re not to the point where you have, you’ve bought materials or you’re actually using the materials yet, but that employee time could still be something that you could pick up.

Paul Van Metre:
Two takeaways, so important for the employees to track time on that, even if it’s not necessarily a work order based manufacturing process. Then, I know it’s really common that a company that is a customer of a shop, they often have designs that they need feedback, they are not sure if it’s manufacturable, and having meetings with them either in person or over Zoom or something where you’re giving feedback about, well, if you change this radius or make this hole this way. So that activity is advising a customer, would qualify?

Vanessa Oviatt:
Yes, as long as it’s related to the design and the manufacturability of a certain product you’re trying to make, then yes, that time can qualify as well.

Paul Van Metre:
Yeah, that’s exactly what that time is, so awesome. Great answer on that.

So Yvonne asks, when we get new jobs from a customer, it isn’t inherently known to us that this is the first time a part is being made. So, I guess we need to ask the customer if it’s truly a new part or just new to us. I’m guessing the answer doesn’t matter, if it’s new to them, that’s what matters.

Vanessa Oviatt:
Yeah, so it has to do with you having to manufacture something, figure out how to manufacture something for the first time. So it can really be new for the company, it doesn’t have to be new to the industry per se. So whatever design process you have to go through, testing process you have to go through to figure out how to manufacture that part, that’s all going to be R&D for the company.

Paul Van Metre:
Yeah, great question, Yvonne. Yeah, it wasn’t clear if the part’s been made for 10 years by another shop and you win it, anything you do on that R&D side that’s new to you.

Lynette asked, would investing in ProShop as our ERP qualify for the credit? I think the question came up when you were talking about cloud storage. So is there anything related to cloud-based software that’s directly related to manufacturing?

Vanessa Oviatt:
Got it, yeah. So unfortunately anything that’s being bought off the shelf for software, off the shelf hardware or equipment, again off the shelf, that’s typically not going to qualify. Now unfortunately, I guess the part about that is that if it is used for R&D activities, it has to be capitalized for 174. So that’s again, part of that broader tax impact of what we’re talking about here, but yeah, usually things that are off the shelf like software is not going to qualify, or ERP systems.

Now, I guess the other side of that is if you do buy something off the shelf, just software in general, and there’s development that needs to be made to fit your needs or for your application, that time that you’re spending, maybe you’ve had to hire someone who has a software background to do that, that time can qualify for that employee. So you just have to see, is there customization being made? Then potentially that can qualify.

Paul Van Metre:
So to put a specific instance on that, let’s say someone is a customer at ProShop and they want to use our API to develop something that’s custom to them that has not been done before. Possibly the time they’re spending with a developer to build something with the API might qualify?

Vanessa Oviatt:
Yeah, potentially, yes. So as long as it’s being… The employees are working through that customization build and using the third-party vendor for it. Yes, that customization piece of it can. I think it just comes down to, is it going to be any payments that are being made for that design, or what you’re doing in-house internally with your people.

Paul Van Metre:
Got it, okay. An anonymous attendee asks, if you operate in a job shop that’s completely custom, every piece is one piece and you’re only making one of each part, would all the activities including machining, be eligible for R&D?

Vanessa Oviatt:
Yeah, so when we’re talking about just a custom component, I think it goes back to that if it’s for a customer. So we do have to look to the customer agreement to see who owns IP rights and then the financial risk.

One thing I will say about just generally speaking about financial risk is that if a customer is paying you to fund the research in any way, then it can’t qualify. A lot of the time that could be a time and materials type of contract, that usually won’t qualify. We usually look at fixed fee contracts and the language itself and saying, okay, is there acceptance criteria? What happens if something goes wrong? So we’re actually looking at contract terms when we’re doing some of this, doing this work. So it depends on the contract.

Now of course, if it’s all in-house, internal R&D, and you’re building a custom component, then potentially yes, everything, all of that could qualify. So I think it just depends a little bit on the fact pattern there, but usually when we’re talking about customers, it gets a little bit more complex because we have to look at those contracts.

Paul Van Metre:
Okay. Well, and I’m going to dig in on this just a little bit myself, so I guess two questions. Let’s say a company is wanting to develop their own product. Sounds like that product development of trying to develop and design a machine and come up with something new that they’re going to sell as their own product, that sounds like that would likely qualify. If they just win a purchase order from a customer for a part that’s a $1,000 and they’re going to sell it for $1,000 to that customer, how does that play into the activities like programming and making a fixture and proving out the program and they’re paying their employees to do that work? How does that relate to the thing you just said about-

Vanessa Oviatt:
Yeah, so we look at it on a project or a job basis. So if it’s a particular contract and the company does for… their customer owns everything, they own all the IP, they’re funding it, whatever. Then we can’t claim anything on that, even if for yourself, you consider it to be R&D, because it’s funded. So it really has to do with the contract itself on a project basis.

Now, if everything is good with the contract and we can look into that project, then yes, any time that you’re putting in as the employee to build something out, to design, to test, even if at the end of the day it’s being sold to a customer, that can all qualify. But it just really depends on that customer contract, which is why internal R&D is always the easy one because you know what cost it is, it’s an investment that the company is making to be able to get that product out. That’s going to be easy, base level R&D to go after. The customer ones just get a little more complicated because it is who is claiming the credit. The company could be saying, oh, anything I paid you as the one helping me make this part, I’m going to be claiming a credit on that. That’s where this funded research issue comes into play because it’s, who’s claiming the credit? Is it going to be you or is it going to be your customer? That goes back to the contract language, so it just gets a little more complex.

Mike Payne:
Paul, can I dig in right there and [inaudible 00:55:22]?

Vanessa Oviatt:
Yes, you sure can, Mike.

Mike Payne:
This may put it a little bit more in perspective for people that use ProShop. Vanessa, I don’t know how familiar you are with the entire ProShop process, but when I create a quote for a new customer, I have my estimating team go through, they look at the print, they price out the material, we assume how long it’s going to take us to do a setup, run the part, create fixtures, all that type of stuff. When I go to take that estimate and create a quote that I’m going to send to the customer, I have a few options. Do I want to include… So there’s some of that that’s non-recurring expense. It’s going to happen the first time we run it, but not every time we run it. Creating that fixture, doing the programming. So I have the option then when I create a quote to include that in the price of the part, include that separate on a separate line item from the quote, or to just ignore it and just say, I’m going to absorb that myself.

Vanessa Oviatt:
I see.

Mike Payne:
So every time we create a quote, we have to make that decision. The way Hill does that is we say, okay, we know we’re quoting this for XYZ customer that if we win it, we’re going to make it for the next 40 years like we’ve been making their other parts for 40 years. So there are times that I say I’m ignoring the non reoccurring expenses. That is an investment I will make as Hill in this company’s part. There’s other times I say, this is a one-time job, I’m charging them for it. I may include it in the price, I may include it as a separate line item. So if I’ve included it in the price or a separate line item, there’s no credit there for me because I’m being compensated for it.

Vanessa Oviatt:
Yeah.

Mike Payne:
Is that true?

Vanessa Oviatt:
Yeah, so the way that that would work and how you would pick it up for the credit would be all that time that you’re spending with that estimating, the requirements and everything, that’s going to be on the employer’s time. So yeah, you would be picking that up as a percentage there.

Mike Payne:
Well, but I’m saying-

Vanessa Oviatt:
But [inaudible 00:57:34]-

Mike Payne:
Let’s say I get the PO. I bid this, I’ve included those non reoccurring expenses in the price of the part, they send it to me, I get it. I’m getting compensated for programming, for creating that fixture for whatever. That is not a R&D tax credit eligible expense then, is that correct?

Vanessa Oviatt:
Not necessarily. It depends. Again, so whether that gets included as the PO or not, it comes down to how you’re getting paid. If you’re getting paid just to manufacture the part and the final deliverable is the part, that doesn’t cover the manufacturing process necessarily.

Mike Payne:
True, okay.

Vanessa Oviatt:
A lot of the time. So anything that you’re doing with the manufacturing process itself to be able to create that part, that is, you’re not getting compensated for that. That’s not being covered by the PO or [inaudible 00:58:31], so.

Mike Payne:
Now, if I exclude the non reoccurring expenses from my quote and I’m saying that’s money I’m investing into making this part for the next 10 years, that definitely, I mean, well, I shouldn’t say definitely, but there’s a really good chance then all of those expenses, whether it’s fixturing, programming, all that type of stuff, then that would qualify. Is that correct?

Vanessa Oviatt:
Yeah, I would say that yes, as I understand it, yes. That would be what would qualify because that’s your expense that’s not being covered by anything that the customer would potentially fund.

Mike Payne:
To a large degree, how we’ve used, how we’ve calculated what we feel is eligible for R&D credits is exactly that, where we’ve said, okay, we made this investment in ourselves, in this product, in this process. We have not charged the customer for it, this is something we did to improve a process or to create a new process to develop a new part or to improve a existing part.

Vanessa Oviatt:
Yep, it’s your expense and if it falls into development, then yes, then you can claim that as part of the credit.

Mike Payne:
Okay.

Paul Van Metre:
Thanks, Mike. That’s good clarification.

We just have a couple questions left, Justin, on updating work orders, we’ll get with you on that. I don’t think you can do that mass update through CSV on work orders, but there might be some other methods by which you could reclassify old work orders or do querying to pull them up. But two things for you guys. How about research on repairing a machine that’s used in manufacturing?

Vanessa Oviatt:
Research on repairing a machine? So I would say no, that probably wouldn’t qualify because I mean, unless it leads to some kind of customization that you have to make to the machine in order for it to get up and running for a certain application, but for just the maintenance and repair of something, I would say no.

Paul Van Metre:
Then does the purchase of new equipment qualify or just depreciation? Or-

Vanessa Oviatt:
Okay, so depreciation. Okay, so the purchase of equipment, if it’s off the shelf equipment, no, it does not qualify. Where you get into this gray area that I was saying earlier is that if it’s a custom piece of equipment, in which case we look to the contracts to take a look through that and see if maybe we could pick up some of that cost. So that one’s in a maybe. Usually off the shelf, no, custom, maybe. Then I would say depreciation, you can’t take that as part of the credit, but depreciation expense does get picked up for 174 to capitalize. So that’s the difference there.

Paul Van Metre:
Okay, awesome. Well, I don’t know about all the rest of you on this, I think this was a super valuable webinar. Thank you, Moss Adams for all your expertise. Thank you, Mike, for your perspective. Yeah, just really appreciate all this. Thanks for all the great questions. Hopefully we covered a lot of good ground and you can go off confidently talking to your tax advisor, or if you need one, reach out to Moss Adams obviously. Yeah, thanks everyone for joining us today. Thanks to the panel, appreciate you all so much and look forward to the next one.

Vanessa Oviatt:
Yeah, thanks for having us.

Mike Payne:
Thanks, Paul.

Amanda Arnold:
Thank you for having us.

Paul Van Metre:
All right, take care, everybody.