How Manufacturers Can Turn Innovation into Tax Benefits

The manufacturing industry has always been at the forefront of innovation. From steam-powered machinery to today’s smart factories, manufacturers have continuously found ways to better their processes. What some may not realize is how impactful this ongoing innovation can be as a financial catalyst.

Recent tax law changes have expanded the definition of qualifying research and development activities and created new opportunities for manufacturers to recover capital on improvements they're already making. Understanding what qualifies and how to capture it can mean the difference between funding the next round of improvements or leaving money on the table.

The Return of Immediate R&E Expensing

The One Big Beautiful Bill Act (OBBBA), signed in July 2025, permanently restored immediate expensing for domestic research and experimental (R&E) costs under Section 174. In recent years, qualifying expenses had to be capitalized and deducted over five years. Manufacturers spending on process improvements recovered only 20 percent of the deduction in year one, with the remainder stretched out over the next four. That delayed payback period made it tougher to make the case for large investments and strained working capital when companies needed it.

Starting in 2025, the full deduction for qualifying domestic expenses can be claimed in the same year the costs are incurred, ending years of uncertainty and providing companies with a more predictable roadmap to long-term planning. Foreign R&E costs, however, remain subject to a 15-year amortization schedule.

Qualifying domestic expenses from tax years 2022-2024 were required to be capitalized and amortized under the old rules. With the changes from OBBBA, the remaining unamortized portion of these expenses can be written off. Companies have the option of writing off 100 percent for tax year 2025 or 50 percent over each year for 2025 & 2026. Be sure to connect with your tax advisor to determine the most tax effective way to write off the unamortized amounts.

Manufacturing Expenses that Qualify

More expenses qualify than most companies realize. R&E can often be camouflaged in work that seems routine, but Section 174 allows manufacturers to deduct expenses directly connected to their operations when the work involves creating or improving a product, process, or system and addresses genuine technical uncertainty.

Qualifying costs fall into three categories: wages, supplies, and contract research expenses. In some cases, all three may apply to the same scenario. If a manufacturer needs to meet stricter VOC emission standards for their coating process, for example, the time engineers spend testing alternative formulas could qualify as deductible wages; the various coating materials consumed during trials generally qualify as supplies; and any payments or fees to third-party labs validating emissions compliance may count as contract research expenses.

While complying with new standards or any number of other seemingly “normal” activities may not seem like R&E, the problem solving and experimentation involved can trigger immediate deductions.

Why Manufacturers Miss These Benefits

The permanent return of immediate expensing can be an invaluable strategy for manufacturing companies, but too often these benefits are overlooked. The most common are outlined below.

• Missed Deadlines. The R&E deduction can be claimed on an original return or later through an amended filing. Amended claims come with heightened review and fixed timelines. The IRS is also phasing in more detailed reporting that may require early planning. Missed deadlines can mean missing out on these savings all together.
• Lacking Documentation. Keeping thorough records of research activities is imperative. Connect labor hours to specific projects, materials to testing activities, and contractor payments to the work being performed. Document as it happens, rather than at the time of filing.
• Unclear Eligibility. Eligibility begins with recognition. Deductions are missed when manufacturers treat work as routine operations despite it involving genuine experimentation and technical uncertainty.
• Disconnected Departments. Coordination between engineering, production, finance, and management determines whether qualifying work gets documented and claimed. Without clear communication channels, eligible expenses remain unreported.
• Deduction vs. Credit Confusion. There are two main tax benefits for research and development activities. Section 174 R&E deduction (discussed in this article) reduces taxable income immediately, while Section 41 R&D credit reduces tax liability dollar-for-dollar. Both apply to the same qualifying work, but there are rules to avoid double claiming expenses. Understanding how they best interact with one another will maximize the total tax benefit. 

In Conclusion

Manufacturers can leverage Section 174 as a powerful strategic planning tool, but there’s a gap between qualifying R&E work and claimed deductions. Work with your R&A advisor to determine what activities may qualify and whether prior-year opportunities exist.