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Industry Insights

R&D Tax Credits for Innovations in Transportation, Logistics and Distribution

Marcy Greenfield, CPA, of Berdon LLP and
Andrea Albanese, and Preeti Sulibhavi of R&D Tax Savers

1.21.20 | Berdon Industry Insights

The old-fashioned brick-and-mortar retail stores are continuing to take on a new avatar: online retail. With the exponential growth of online shopping, the need for distribution centers and warehouses to store and distribute their goods to intermediary and end-user customers has also vastly increased. Previously, when capacity was tight, distribution centers focused on increasing density. In today’s Internet-based economy, the goal is to persistently improve throughput–making warehouses and distribution centers the new retail engines. In response to this shift, the implementation of process improvements and new technologies is essential for distribution centers and warehouses to increase throughput, as well as qualify for federal and state research and development (R&D) tax credits.

The tireless nature of the warehouse occupation, where workers are constantly lifting heavy loads, has resulted in manual labor shortages in the transportation, logistics and distribution (TLD) industry. This has subsequently motivated technological innovation in the industry, as facility and warehouse operations managers are striving to increase innovation to meet the current demands of the market.

This article, which focuses on warehouse management systems (WMS), is the first in a series that will discuss some TLD technology integration and process improvement activities which typically qualify for R&D tax credits. It is important to note that many of these eligible activities may also apply to other related industries, including manufacturing and retail.

The R&D Tax Credit

Enacted in 1981, the now permanent federal R&D tax credit allows a credit that typically ranges from four to seven percent of eligible spending for new and improved products and processes. Qualified research must:

  • Be technological in nature,
  • Be a component of the taxpayer’s business,
  • Represent R&D in the experimental sense and generally includes all costs related to the development or improvement of a product or process, and
  • Eliminate uncertainty through a process of experimentation that considers one or more alternatives.

Eligible costs include U.S. employee wages, cost of supplies, cost of testing, contract research expenses, and certain costs associated with developing a patent.

In 2016, major updates to the R&D tax credit were enacted. This included President Obama signing the PATH Act and making the R&D tax credit permanent, as well as allowing the credit to offset the Alternative Minimum Tax and enabling start-ups to utilize the credit against payroll taxes.

Case Study: Federal Express—Paving the Future for R&D Tax Credits in TLD

In the late 1990’s, Federal Express (FedEx) invested heavily in package tracking and the use of internal software related to it. Internal-use software R&D tax credit claims are known to have an additional set of tests to meet, in addition to the four criteria discussed above. Requirements include that the project involve economic risk and must not be available off the shelf. The IRS challenged the FedEx claim, asserting that internal software claims “had to be unique or novel, had to be as significant and inventive as prior software based on new regulations.” The court, however, disagreed with the IRS’ approach and allowed FedEx to take the R&D tax credit. In recent years, software has become much more integral to the U.S. economy, and the FedEx case highlights how the entire TLD industry is no different. It became clear that the TLD industry can be entitled to R&D tax credits, thanks to FedEx winning this important tax case.

Like the FedEx investment in technology, companies in the TLD industry are making great strides to implement new and improved technologies. One example of these improvements can be found in new software being implemented in warehouses and distribution centers.

Warehouse Management Systems (WMS)

Software-based Warehouse Management Systems (WMS) are increasingly being used by larger warehouses and distribution centers. For most companies involved in TLD, warehouses represent substantial cost centers and are key strategic assets, as they are also where Internet-based customer promises are fulfilled. WMS utilizes real-time transaction processing, optimizes storage and selection strategies, directs task management and integrates labor standards to maximize labor efficiency, reduces obsolescence and leverages available capacities. WMS also optimizes customer service by coordinating the digital transition via current functionality, innovative automation, and focusing on configuring the warehouse framework to encourage testing and experimentation. In an unpredictable world, consistency is critical. WMS is a cost-controlled, customer-centric means of achieving consistent, predictable results—in an ever-changing environment.

Companies implementing WMS often have a larger overall initiative to increase efficiency and throughput—providing additional R&D tax credit opportunities. Combining a WMS with other process improvement activities provides companies with the potential to generate even more substantial R&D tax savings than incorporating a WMS alone.

Below are some recent case study scenarios of companies implementing WMS and other process improvements. The R&D tax credit scenarios below were mainly driven by the companies’ employee expenses and outside contractor expenses.

Dept. Store Distribution   
Qualified ExpensesR&D Tax Credit
Year 2$2,177,837$152,073
Year 1$821,744$32,048
E-Commerce Distribution   
Qualified ExpensesR&D Tax Credit
Year 4$6,124,345$227,702
Year 3$4,606,094$176,639
Year 2$3,772,086$116,721
Year 1$3,179,229$88,868

The stereotype that TLD centers are vast warehouses with little to no innovative processes certainly does not hold true today. Throughput analysis, automated processes, and innovative technology to coordinate product fulfillment are almost standard with any considerable TLD operation. Often, innovation is motivated by how good the end-product will be. In the case of TLD, innovation is motivated by how efficiently companies can get the end-product to the customer.

The same R&D tax credit opportunities apply for manufacturing, wholesalers, retailers, and other companies performing similar activities. Regardless of the industry, making investments in technology and/or process improvements enables companies to utilize lucrative R&D tax credit incentives to fuel further innovation and overall growth.

Questions? Contact Marcy Greenfield at 516.806.3425 | mgreenfield@berdonllp.com or your Berdon advisor.

Berdon LLP New York Accountants