October 20, 2026 Understanding the R&D Tax Credit for Manufacturers

R&D tax credits can help American manufacturers save hundreds of thousands of dollars in taxes. Do you know if you qualify?

JP Mazzocco, Associate Director of Tax Operations at Arvo Tech

Manufacturing contributed around $2.9 trillion in added value to the U.S. economy in 2025. Taken alone, that would make the American manufacturing industry the world’s eighth-largest economy. Innovation is at the heart of that success: U.S. manufacturers are responsible for over half the nation’s private sector research and development.

Over several decades, the U.S. has developed and implemented tax policies aimed at fostering innovation. In 1954, the addition of Section 174 to the federal tax code allowed companies to deduct qualified expenses for R&D in the year they were incurred. Then, in 1981, Congress enacted the R&D tax credit, which businesses could use to offset income taxes. This tax credit was expanded in 2015 to provide startups with a valuable payroll tax offset.

The Inflation Reduction Act doubled that opportunity in 2022, letting qualified small businesses — those with under $5 million in gross receipts, within five years of their first revenue — offset up to $500,000 in payroll taxes (split between Social Security and Medicare) rather than the original $250,000 cap.

Manufacturers were exactly the kind of companies policymakers had in mind when they first introduced these changes. By offering tax benefits to businesses that engaged in R&D, they could encourage innovation and, in turn, stimulate economic growth and job creation. The tax benefits remain highly valuable to the manufacturing industry today. Provided they’re properly documented, costs related to developing new or improved products, production processes, and manufacturing techniques can all qualify for the deduction and credit.

These R&D tax credits are a significant financial opportunity for manufacturers, but many aren’t aware they qualify. Taking advantage of these tax benefits could allow qualifying manufacturers to save hundreds of thousands of dollars on their taxes.

What’s Behind the R&D Tax Credit Opportunity?

Section 174, written into the tax code in 1954, provided companies with clarity in the treatment of R&D spend. This provision allowed a 100% deduction of their qualified R&D expenses or the choice to capitalize the costs. In 2022, legislation passed five years earlier led to a change in the provision. Instead of deducting all research expenses in the year they were incurred, companies could only capitalize and amortize those domestic costs over five years — or over fifteen years for costs incurred outside of the U.S. This change limited deductions for innovative businesses, and it often put companies in a difficult tax-paying position as a result.

Even before the policy went into effect, federal policymakers understood the negative impact it would have. Several bills were introduced in Congress between 2018 and 2025, including provisions to restore the immediate deduction of research and experimentation expenses for the tax year 2022 and after. However, none of the bills were enacted into law.

Finally, legislation passed in 2025 led to change. The addition of section 174A to the tax code saw the permanent reinstatement of full tax deductions for domestic spending starting with the 2025 tax year. This change will benefit innovators in a wide range of industries, as they reduce their taxable income and receive savings related to both the deduction and to R&D credits. Manufacturers stand to gain significantly, as long as they can accurately categorize their research expenses.

How Can Manufacturers Take Advantage?

Adapting your tax strategy to accommodate a little-known provision might sound like a major undertaking, but it’s not as complicated as it seems. Categorizing expenses is straightforward, and manufacturers can lean on specialized tax companies to help gather information ahead of the deadline.

Manufacturing firms can include three types of costs when calculating the federal research credit:

1. Wages: Paid to U.S.-based employees working on new products and processes, such as design and process engineers or those improving production processes
2. Contract expenses: 65% of contract research expenses, U.S.-based only
3. Supplies: Non-capital/non-depreciable supplies used or consumed in the development process, such as prototype materials and tooling

Under Section 174 of the tax code, deductions include the research credit expenses above and other categories of research and experimentation spend that depend on the business. Rather than adopting this approach to R&D tax credits as a one-time opportunity, companies should focus on making R&D tax benefits a part of their long-term financial strategy. Documenting the time employees spend on designing and developing new technologies, testing designs, and other R&D activities helps simplify the process. Understanding which tasks don’t qualify, such as standard design development or administration, is just as important to ensure accurate accounting. 

American manufacturers are already leading the way when it comes to research and development. By taking advantage of the R&D tax credit and the return of full deductions for R&D spend, manufacturing firms can reinvest in innovation and create a virtuous cycle to drive the industry forward.

Key Takeaways

• The addition of section 174A to the tax code reinstated full tax deductions for domestic spending starting with the 2025 tax year.
• American manufacturers could save hundreds of thousands in taxes, but many don’t know they qualify.
• Manufacturing firms can include three types of costs: wages, contract expenses, and supplies.
• Specialized tax companies can help firms gather the required information.

About the Author:
JP brings over a decade of tax expertise to Arvo Tech, including specialized R&D credit experience at Clarus R+D and EY.

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