The research credit is back and maybe better than ever. This business credit, which had expired and been reinstated numerous times since its inception in 1981, was permanently preserved by the Protecting Americans from Tax Hikes (PATH) Act of 2015. What’s more, the PATH Act version of the credit contains a couple of key enhancements, making it even more attractive to some manufacturing firms.

Now the IRS has issued interim guidance relating to the “new and improved” research credit. The guidance provides important information on an election for qualified small businesses. (Notice 2017-23, 3/31/17)

Background Information

The research credit is intended to encourage spending on research activities by established firms and startups. In its current form, the credit generally equals the sum of:

• 20% of the excess of qualified research expenses for the year over a base amount,
• The university basic research credit (i.e., 20% of the basic research payments), and
• 20% of the qualified energy research expenses undertaken by an energy research consortium (see box).

For this purpose, the base amount is a fixed-base percentage (not to exceed 16%) of average annual receipts from a U.S. trade or business, net of returns and allowances, for the four years prior to the year of claiming the credit. It can’t be less than 50% of the annual qualified research expense. In other words, the minimum credit is equal to 10% of qualified research expenses (50% rule times the 20% credit).

But be aware that the credit is available only for qualified expenses. This includes an expense if:

• It qualifies as a research and experimentation expenditure under Section 174 of the tax code,
• It relates to research undertaken for the purpose of discovering information that is technological in nature and the application of which is intended to be useful in developing a new or improved business component, and
• Substantially all of the activities of the research constitute elements of a process of experimentation that relates to a new or improved function, performance, reliability or quality.

When the PATH Act permanently preserved the research credit, it improved it for qualified small businesses in two ways:

1. AMT liability. Effective for 2016 and thereafter, an eligible small business may claim the research credit against alternative minimum tax (AMT) liability. For this purpose, the business must have $50 million or less in gross receipts.

2. Payroll taxes. Also effective for 2016 and thereafter, a qualified small business may elect to claim the research credit against up to $250,000 in payroll taxes annually for up to five years. In this case, the company must have less than $5 million in gross receipts.

Regarding the payroll tax election, the credit amount is applied against the Old Age, Survivors and Disability Insurance (OASDI) tax liability paid for employees, the portion of FICA commonly called “Social Security tax.” For wages earned in 2017, the employer share of Social Security tax is equal to 6.2% of each employee’s wages up to a base of $127,200. The Social Security Administration (SSA) adjusts this wage base annually.

A manufacturing firm or other business entity must make the election to use the research credit against payroll tax liability on an original return. Thus, the election can’t be claimed on amended returns. Because the election takes effect for credits generated in 2016, it is available to offset payroll taxes during the second quarter of 2017.

New IRS Guidance

The new Notice includes interim guidance with respect to the payroll tax election.

First, it clarifies that the definition of “gross receipts” used to qualify a business is determined under Section 448(c)(3) of the tax code without regard to Section 448(c)(3)(A) and its accompanying regulations. In essence, this means that there’s no exclusion of amounts representing returns or allowances, receipts from the sale or exchange of capital assets under Section 1221, repayments of loans or similar instruments, returns from a sale or exchange not in the ordinary course of business and certain other amounts.

Second, to make a payroll tax credit election, the IRS requires a qualified small business to attach a completed Form 6765 (Credit for Increasing Research Activities) to a timely return, including any extensions, for the appropriate tax years.

Third, the new Notice provides interim relief for qualified small businesses that filed returns for tax years after 2015 in a timely fashion, but failed to make the payroll tax credit election. In this case, the entity may make the election on an amended return filed on or before December 31, 2017. To accomplish this, the business must either:

• Indicate on the top of its Form 6765 that the form is “FILED PURSUANT TO NOTICE 2017-23;” or
• Attach a statement to this effect to the Form 6765.

A qualified small business can claim the payroll tax credit for the first calendar quarter beginning after it makes the election by filing the Form 6765. Similarly, if the small business files annual employment tax returns, it may claim the credit for the return including the first quarter beginning after the date on which the business files the election. The business is instructed to attach a completed Form 8974, providing the Employer Identification Number (EIN) shown on Form 6765, to the employment tax return.

When your small business files quarterly employment tax returns, use Form 8974 to apply the Social Security tax limit to the amount of the payroll tax credit elected in Form 6765 to determine the credit amount allowed on its quarterly return. If the payroll tax credit elected exceeds the employer share of the Social Security tax for that quarter, the excess determined on Form 8974 is carried over to the next quarter, subject to the applicable Social Security tax limit.

The new guidance, which is technical in nature, is probably best left to the tax professionals. What manufacturing firm owners and managers can take away is the realization that the research credit, which is valuable in its own right, can now be used to offset payroll tax liability for qualified small businesses. Factor this into your business decisions.

Simple Does It

In lieu of claiming the regular 20% research credit, your firm can rely on the alternative simplified credit (ASC).

Currently, the ASC is equal to 14% of the amount by which qualified expenses exceed 50% of the average for the three preceding tax years. The ASC, which first became available in 2007, replaced the alternative incremental research credit (AIRC).

Some manufacturing firms prefer the ASC to the regular credit. For instance, the ASC may be used instead of the regular credit if the firm has a high base amount for the regular calculation, doesn’t have detailed records to support qualified expenses during the base period years, has experienced significant growth in receipts in recent years or has a complex history of organizational activity (e.g., mergers, acquisitions and dispositions).

President Trump rode to victory on a platform that included a promise to “Make America Great Again.”

That idea can lead manufacturers and other companies to proudly proclaim their products are “Made in USA.” But a company can’t simply make that or similar claims without substantiation. Recently, the Federal Trade Commission (FTC) reached settlements within weeks in two similar cases where it charged the companies with making unfounded claims about where their products were made or built.

What Does the FTC Require?

Historically, the FTC has required that a product advertised as “Made in USA” be “all or virtually all” made in the United States. The term “United States” here refers to the 50 states, the District of Columbia, and the U.S. territories and possessions.

The requirement applies to all products advertised or sold in the United States, unless they are subject to country-of-origin labeling by other legislation. It also applies to U.S. origin claims that appear on labeling and all other forms of promotion or marketing, including digital or electronic, such as on the Internet or in emails.

Similar Claims and Outcomes

The two recent cases before the FTC involved settlements containing consent orders where the companies agreed to stop claiming their products were either built or made in the United States.

Case #1: The FTC charged that a Georgia-based distributor of water filtration systems deceived consumers by presenting false, misleading or unsupported claims that the systems and parts were:

• “Built in USA,”
• “Built in USA Legendary brand of water filter (sic),” or
• “Proudly Built in the USA.”

The company marketed the water filtration products on its own and third-party websites.

The FTC maintained that the products were wholly or partially imported and a significant amount of the production occurred overseas.

“Supporting American manufacturing is important to many consumers. If a product is advertised or labeled as ‘made’ or ‘built’ in the USA, consumers rightly expect that to be the case when they part with their hard-earned money,” said Acting FTC Chairman Maureen Ohlhausen. “This is an important issue for American business and their customers, and the FTC will remain vigilant in this area.”

Case #2: Just five weeks after the water-filtration settlement, the FTC settled charges that a Texas-based distributor of pulley block systems deceived consumers with false, misleading and unsupported claims that the products and other items were “Made in USA.”

The FTC asserted that the company represented that its products and parts were completely or virtually all made in the United States in its advertising. The claims appeared in various places, including on its website, in stores, through trade shows and authorized dealers, and on social media, flyers and pamphlets.

The products actually included substantial imported parts that are essential to functionality. In addition, the pulleys featured steel plates imported and prestamped as being made in the United States.

U.S. Origins Claims Banned

As part of both final consent orders, the two companies are banned from making “Made in USA” or similar claims for any product unless they can show that:

1. The final assembly or processing — and all significant processing —took place in the United States, and
2. All or virtually all ingredients or components of the product were made and sourced in the United States.

They are prohibited from making any country-of-origin claims about their products unless the claims are true and not misleading and they have a reasonable basis for making them. The companies are allowed to make qualified “Made in USA” claims as long as they include a clear and conspicuous disclosure about the extent to which the product contains foreign parts, ingredients and/or processing.

The penalty for breaking a final consent order by the FTC is severe. Each violation can result in a civil penalty of up to $40,654.

Be Certain Ground Is Firm

If your manufacturing company says its products are made in the United States, be certain you are on firm ground. Not only can unsupported claims result in loss of revenue and sanctions, but they can irreparably harm a manufacturer’s reputation.

Is It Express or Implied?

A claim by a manufacturer of “Made in USA” may be express or implied.

Some examples of express claims are “Made in USA,” “Our products are American-made,” and “USA.” That’s easy to understand and identify.

But for implied claims, the FTC focuses on the overall impression of the advertising, label or promotional material. Depending on the context, U.S. symbols or geographic references (U.S. flags, outlines of U.S. maps or references to U.S. locations of headquarters or factories, etc.) may convey a claim of U.S. origin by themselves or in conjunction with other phrases or images.

Here’s a typical example from the FTC:

“A company promotes its product in an ad featuring a manager describing the ‘true American quality’ of the work produced at the company’s American factory. Although there is no express representation that the company’s product is made in the U.S., the overall impression likely conveyed by the ad to consumers is that the product is of U.S. origin. This implied claim could run afoul of the FTC policies.”

If you plan to advertise a product as made in the United States, consult with your advisors to ensure you have enough facts, statistics or other substantiation for the claim.

The manufacturing supply chain is only as strong as its weakest link. But how does a firm know where its weakest link lies?

To that end, the philosophy of predictive analytics is taking root. As the name suggests, this branch of advanced analytics uses many techniques to predict where a system can break down, so it can be fixed beforehand.

The trend is clear. According to recent data from MHI, a North Carolina-based supply chain trade association, almost 25% of companies have adopted predictive analytics. That number is expected to skyrocket to 70% over the next three to five years.

Higher Standards

The public expects goods to be delivered when promised and at competitive prices. As a result, manufacturers are being held to higher standards. They need to know more than when to expect delivery from suppliers so they can adjust production and delivery schedules. This sets the stage for predictive analytics.

By applying advanced statistical analysis of big data to identify patterns and predict events, manufacturers are better able to anticipate the current and forecasted needs of customers. Thanks to advances in technology, the data that is now available to supply chain manufacturers is so huge and complex that some manufacturers are discarding historical planning methods.

In fact, innovations in supply chain management are taking place at a lightning-fast pace. Firms that don’t adapt — and adapt soon — may struggle to remain competitive and deliver orders accurately and on time.

The Question of Price

Of course, the shift to predictive analytics comes at a price in terms of software and related costs, and at a time when manufacturers are being forced to cope with ever-rising costs of materials and goods.

This isn’t the first time that promises about forecasting capabilities have been pitched to the manufacturing sector. Companies have been encouraged to spend on many technological innovations over the past few decades, with varying degrees of success, and may be gun-shy about further financial commitments in this area.

So what makes predictive analytics different?

Some industry experts point to the cloud. Storing vast amounts of data over the Internet makes it possible for companies to access information that helps them make better decisions and gain valuable insights into potential problems.

For example, say a company makes refrigerators and ovens. The components may be produced by outside contractors, which can make it difficult to pinpoint where a failure in production may occur. The company may determine when the process is most likely to break down using predictive analysis and such factors as:

• Production line,
• Quantities,
• Time of production,
• Number of engineering changes,
• Consumer usage patterns, and
• Demographics.

Most Common Benefits

Predictive analytics is most often associated with benefits in four main areas:

1. Quality improvement. This might be job number one. Improvement in databases and storage, supplemented by easy-to-use, analytical software, is a major factor in improving the quality of a company’s products. Manufacturers can store more data about their products and processes, which lets them analyze more factors to help improve quality. This, in turn, aids in forming a definitive plan of action.

2. Demand forecast. Forecasting is critical to success. Manufacturers must project the products desired, quantity needed and required delivery time. Traditional demand forecasts were based mainly on experience. A company could predict with reasonable certainty that some products would sell faster or in greater bulk during particular seasons (for example patio furniture for the summer or ski equipment for the winter). That hasn’t changed, but predictive analytics adds another layer by allowing companies to consider more factors.

Predictive analytics paints a comprehensive picture that identifies likely trends and other events based on historical data collection and analysis. It combines demand forecasting with risk management using fewer resources.

3. Equipment improvement. Manufacturing firms that provide quality goods generally use quality machines. However, even the best equipment breaks down or experiences wear and tear over its useful life. Replacing parts or updating the equipment can cost thousands of dollars.

Predictive analytics can anticipate equipment failures. By automating the analysis of data from sensors within equipment — as well as the actual operation of these machines — a firm may determine when machines should be replaced before any damage occurs. This saves both time and money.

4. Preventive maintenance. Similarly, firms can reduce operational issues by triggering alerts from machines, based on data they provide internally. For instance, automatic signals could be sent when a belt or gear is torn or broken, reducing the burden on a particular machine or identifying patterns for certain types of equipment.

This is a critical step for ensuring equipment continues to operate at maximum efficiency. At other times, predictive analytics could be used to identify manufacturer defects in machines.

Focal Point

Competition in manufacturing is fierce and advances in technology only up the ante. Use of predictive analytics in manufacturing is expected to increasingly become a focal point. If you want your company to be among the leaders of the manufacturing renaissance, consider hopping on the predictive analytics bandwagon sooner rather than later.

The Positive Side-Effects

Predictive analytics is proactive rather than reactive. This can enable:

• Parts analysis. Software can show which parts will fail first and which will last the longest. Management can then adjust inventory, stockpiling certain parts that are likely to wear out and bulk-ordering replacements ahead of time.
• Cost-benefit analyses. By conducting enhanced cost-benefit analyses, manufacturing teams can better understand the risks of not performing maintenance at any given time.
• Warranty claims. Companies can assess warranty offerings based on the insights gleaned from the analysis.
• Risk mitigation. Manufacturers may be able to avoid penalty fees by fixing issues before they escalate.