Process work on the shop floor can qualify for the federal research credit on its own, even when the product has been in production for years. Section 41 treats a plant process, machinery or technique for commercial production as a business component separate from the product it makes, and tests it under the same four-part test.
Most of the analysis turns on the line between experimentation and ordinary production. Routine quality control, efficiency surveys, management-based changes and work done after a process is ready for commercial use are excluded. Supplies consumed in a qualifying trial can count; depreciable equipment cannot count as a supply, although wages to design and test it may.
Why a Manufacturing Process Is Its Own Business Component
Section 41(d)(2)(B) names a process as one type of business component. Section 41(d)(2)(C) adds that any plant process, machinery or technique for commercial production is a separate business component, not part of the product being produced.
The product’s status does not end the process’s eligibility. Under Treas. Reg. 1.41-4(c)(2)(iii), the commercial production exclusion applies separately to product and process development. Process work may still be qualified research after the product meets the company’s basic functional and economic requirements, if the process work separately qualifies and occurs before the process itself meets the company’s basic functional and economic requirements or is ready for commercial use.
The test can narrow to the part that is new. Under the shrinking-back rule in Treas. Reg. 1.41-4(b)(2), the requirements apply first to the whole business component and, only if it does not qualify, to the most significant subset of elements, such as a new fixture or control routine. The rule is not itself a reason to exclude research.
Applying the Four-Part Test to a Process Change
Our guide to the four-part test and our overview of R&D tax credits for manufacturers cover the basics. For a process, a few points in Treas. Reg. 1.41-4(a) tend to decide the answer.
- Uncertainty about method or design. Uncertainty exists if the information available does not establish the capability or method for the improvement, or its appropriate design: for example, which parameters, sequence, material or equipment design will hold yield or tolerance at production rate.
- No need to advance the field. The research does not have to exceed the common knowledge of skilled professionals in the field, but the method or design must still be uncertain to the company.
- Evaluation of alternatives. Experimentation means identifying alternatives and evaluating them through modeling, simulation or systematic trial and error. Adjusting a machine until parts pass, with no record of what changed, is difficult to support.
- A technical purpose. The work must relate to function, performance, reliability or quality. Yield, scrap and cycle-time goals can relate to process performance or quality, but savings alone, without a technical uncertainty, do not make work qualified research.
- Substantially all. At least 80 percent of the research activities must be elements of a process of experimentation.
The regulations’ example shows where process research stops. A tire maker’s work designing and testing alternative belts for tread cooling may be qualified research, but its costs to manufacture, install and test the belts after the design met its requirements are excluded.
What the Exclusions Remove From Shop-Floor Claims
Section 41(d)(4) excludes several activities that look technical on a plant floor.
- Research after commercial production. The regulations deem preproduction planning for a finished component, tooling-up, trial production runs, troubleshooting faults in production equipment or processes, accumulating production data and debugging to fall after commercial production begins. For a process, the question is when the process itself met its requirements.
- Adaptation. Adapting an existing component to a particular customer’s requirement is excluded, but the exclusion does not apply merely because a component is intended for a specific customer.
- Duplication. Reproducing an existing component from examination, plans, blueprints, specifications or public information is excluded.
- Efficiency surveys and management functions. These include management-based changes in production processes; the regulations’ example is rearranging work stations on an assembly line.
- Routine quality control. The section 174 regulations describe quality control testing as checking whether particular units conform to specified parameters, which does not include testing whether a design is appropriate.
Contract manufacturers should also check the funded research exclusion when a customer pays for the development work.
Common Shop-Floor Activities and Their Likely Treatment
Every project turns on its own facts; the table shows general tendencies.
| Activity | May qualify where | Likely excluded where |
| Yield, scrap and rework reduction | The method to fix it is uncertain and alternatives are tested | The fix is a known adjustment, or the work is tracking rates |
| Cycle time reduction | New parameters, tooling or controls with an uncertain effect are tested | Time comes out by rebalancing stations or staffing |
| Tooling, fixtures and dies | The design is uncertain and alternatives are built and tested | Copies of a proven design are built and installed |
| Automation and controls | Modifying equipment or control logic raises design uncertainty | Standard equipment is installed and set up as specified |
| New materials | It is uncertain how the process must change to run the material | The material runs as a drop-in substitute |
| Process validation trials | Runs test whether the process design can meet its targets | Runs confirm a settled process conforms to specifications |
Supplies Consumed in Trial Runs Versus Depreciable Property
Section 41(b)(2) counts supplies used in the conduct of qualified research, and excludes land, improvements to land and depreciable property from the definition.
Materials the experiment consumed. Resin, bar stock, coatings and parts scrapped in a qualifying trial can be qualified research expenses (QREs). In a CSSI Services manufacturing case study, a formulation project for an elastomer compound, qualifying supply costs of $3,525,628 came close to the $3,888,963 in qualifying wages.
Material production would have used anyway. In Union Carbide Corp. v. Commissioner (2d Cir. 2012), the court held that supplies used in production that would have been used regardless of the research were not creditable. Trials run on a live line with saleable output need to identify what the experiment itself consumed.
Equipment, molds and pilot models. Depreciable machines, molds and fixtures are not supplies, and depreciation is not an in-house research expense under section 41(b)(2), although wages to design and test them may qualify. In the pilot model example in the section 174 regulations, a machine builder’s costs to build and test a model that resolved design uncertainty were research expenditures, but the cost of then building the machine for sale was not. Whether materials in a prototype tool later placed in production are supplies or depreciable property depends on the facts.
Documentation That Shows Experimentation on the Shop Floor
Treas. Reg. 1.41-4(d) requires records “in sufficiently usable form and detail to substantiate that the expenditures claimed are eligible for the credit.” For process work, that usually means records kept by business component as the work happens:
- a plan stating the target and what was unknown at the start;
- run sheets showing the alternatives tried, settings, material lots and results;
- trial scrap and yield data kept apart from production reporting;
- material issues or work orders tying trial materials to the project;
- time records for the engineers and technicians involved;
- a dated record of when the process was released to production, which helps show where qualified research on it ends.
To see whether your plant’s process work qualifies, you can request a free analysis, estimate the credit with our R&D tax credit calculator, or read more about CSSI’s R&D tax credit services for manufacturing.
Frequently Asked Questions
Can process work qualify if the product has been in production for years?
Yes. The process is a separate business component, so research on a new or improved process may qualify until that process meets the company’s basic functional and economic requirements or is ready for commercial use, if it meets the four-part test.
Does lean or continuous improvement work count?
Usually not by itself. Efficiency surveys and management-based changes, such as rearranging work stations, are excluded. A project can include qualifying work where it resolves a technical uncertainty through experimentation, such as testing alternative process parameters or fixture designs.
Are materials used in trial runs qualified research expenses?
They can be, if used in the conduct of qualified research. Materials that ordinary production would have used anyway were held not creditable in Union Carbide.
Does the cost of a new machine or mold count toward the credit?
Generally not as a supply, because equipment and molds are usually depreciable property. Wages to design and test an uncertain design may qualify; building and installing production units after the design is proven generally does not.
How does Form 6765 handle process research?
Section G of Form 6765, required for tax years beginning after 2025 unless an exception applies, asks for information by business component and whether each one is a product, a process or all others. Defining process components when projects start makes that reporting easier to support.
This article provides general information about federal tax rules and is not tax advice. Speak with your tax adviser about your specific circumstances.
