United States

How rising fuel economy standards create tax credit opportunities

Taking advantage of research and development


A new car in 2025 will go twice as far on a gallon of gas as a 2012 model does, as long as auto manufacturers comply with the new Corporate Average Fuel Economy (CAFE) regulations set for the 2017-2025 model years. CAFE standards were first enacted by Congress in 1975 in order to ensure that auto manufacturers comply with the fuel economy standards set by the Department of Transportation. The purpose of CAFE is to reduce energy consumption by increasing the fuel economy of cars and light trucks. The EPA is responsible for administrating the CAFE program. It provides all the fuel economy data that is used on the fuel economy label or window sticker on all new cars and light trucks. The National Highway Traffic Safety Administration (NHTSA), is responsible for monitoring CAFE compliance. It is authorized to assess penalties based on the information the EPA supplies and to modify the standards.

NHTSA set new standards to increase CAFE levels rapidly over the next several years, which will improve our nation's energy security and save consumers money at the pumps. The program applies to light duty cars and trucks in two phases – model years 2012-2016 and model years 2017-2025. The first phase went into effect in 2010 with a target of an overall average CAFE level of 34.1 mpg. The new target for phase two of the program states that fuel economy averages for U.S. light vehicles produced during the 2017-2025 model years will increase to 54.5 mpg.

So what effect do these standards have on the auto manufacturers? When faced with the concern of reducing the fuel emissions, the manufacturers are being forced to take a holistic approach to reviewing their entire design processes. In reality, there is no magic solution to meeting the standards; however, major auto manufacturers are already developing advanced technologies that can significantly reduce fuel use and greenhouse gas emissions into the phase two model years. In addition, a wide range of technologies are currently available for automakers to meet the new standards, and consumers can expect to see an emphasis on the increased efficiency of conventional powertrains, advanced gasoline engines and transmissions, vehicle weight reduction, lower tire rolling resistance, improvements in aerodynamics, diesel engines, more efficient accessories, varying degrees of electrification and improved air conditioning systems, just to name a few. In fact, many Tier 1 suppliers are evaluating dedicated engineering and development facilities to explore further the many emerging technologies and trends in the automotive sector. 

The increased pressure from CAFE standards, the need to reduce operational costs and suppliers' role in developing new content continue to transform the automotive industry and reshape its research and development (R&D) practices.  Automotive manufacturers can help mitigate cost and risk of R&D by leveraging available federal, state and local tax incentives, specifically the R&D tax credit.

Despite common perception, the definition of R&D for tax purposes extends beyond new product development and can include activities that occur in the wider business areas, such as manufacturing operations and assembly processes, testing and trialing, quality assurance, regulatory certification and business services.

Examples of automotive initiatives that may be eligible for R&D tax incentives include:

  • Automation of manufacturing processes
  • Exploration of new material use (e.g. high tensile steel, composites, aluminum, stamping process and technologies, etc.)
  • Trials to improve process efficiencies, throughput or reduce waste and costs
  • Designing and fabricating prototypes or tooling
  • Process development to increase reliability, increase efficiencies or throughput
  • Design and development to improve vehicle performance, e.g., aerodynamics, fuel efficiency, etc.
  • Feasibility studies of concept vehicles and technologies
  • Development and perfection of new material bonding technology (e.g. friction welding, 3D lock seams, etc.)
  • Manufacturing trials to resolve technical challenges with scaling up new products to full-scale production
  • Prototype testing of vehicles and components resulting in a new or improved product
  • Improvements in structural performance or crash worthiness

In addition, the IRS recently enhanced the ability for taxpayers to amend prior year tax returns by permitting them to calculate the R&D tax credit using the alternative simplified credit method which uses the prior three years to calculate the base period versus a base period dating back to the mid-1980s.

Beyond the federal R&D tax credit, many states also offer R&D tax credits, as well as other economic incentives for R&D-oriented efforts.

Automotive manufacturers are likely performing a significant amount of R&D activities due to the requirement to meet the increasing CAFE standards.  Thus, the manufacturers should review their activities and explore taking advantages of the benefits associated with claiming federal and state R&D tax credits, in addition to exploring other economic incentive programs that may be available.

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Steve Menaker 
National Manufacturing Practice Leader



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