Massachusetts General Laws Chapter 63, Section 38M: A Comprehensive Analysis of the Research and Development Tax Credit

Massachusetts General Laws Chapter 63, § 38M provides a corporate excise tax credit for businesses that invest in qualified research and development activities conducted specifically within the Commonwealth. It allows for a primary credit of 10% on incremental qualified research expenses and 15% on basic research payments, subject to strict utilization caps and carryforward provisions.1

The statutory framework established under § 38M represents a critical pillar of the economic strategy of Massachusetts, designed to maintain its position as a global leader in innovation-driven sectors such as biotechnology, software engineering, and advanced manufacturing. By anchoring the credit to the federal Internal Revenue Code (IRC) while maintaining state-specific limitations, the law balances the need for a familiar compliance environment with the state’s requirement to ensure that tax benefits correlate directly with local economic activity. The implementation of this credit is managed through a complex interplay of the General Laws, the Code of Massachusetts Regulations (CMR), and Technical Information Releases (TIRs) issued by the Department of Revenue (DOR). This analysis explores the mechanical nuances of the law, the administrative interpretations provided by the revenue office, and the strategic implications for corporations navigating the Commonwealth’s fiscal landscape.

Historical Evolution and Statutory Framework

The Massachusetts Research Credit was originally enacted to incentivize the growth of the knowledge economy by reducing the after-tax cost of innovation. Codified as MGL c. 63, § 38M, the law applies to business corporations subject to the corporate excise tax under Chapter 63. This includes both domestic and foreign corporations, and as of recent judicial and administrative developments, financial institutions.1 The legislative intent of § 38M is to provide a tiered incentive structure. The “regular” method focuses on rewarding companies that exceed their historical average R&D intensity, while the more recent “alternative simplified method” (ASM) provides a path for companies with volatile R&D spending or those lacking historical data.1

Furthermore, the statute specifically targets the residency of the research activity. Unlike the federal credit under IRC § 41, which applies to research conducted anywhere in the United States, § 38M is strictly limited to expenses incurred for research conducted within the borders of Massachusetts.7 A defining characteristic of § 38M is its static conformity to the federal tax code. For the purposes of defining qualified research expenses, basic research payments, and other core terms, the statute refers to IRC § 41 as it was amended and in effect on August 12, 1991.1 This creates an administrative complexity for modern taxpayers, as the federal credit has evolved significantly since 1991, yet the Massachusetts credit remains tied to that specific version of the Code for its fundamental definitions.

The static conformity ensures that Massachusetts does not automatically adopt federal changes that might inadvertently expand or contract the state’s tax base without legislative review. However, it requires practitioners to maintain a deep understanding of the 1991 IRC rules while applying modern Massachusetts-specific calculation methodologies. For example, while federal law has updated its definitions of software development and contract research over the decades, the Massachusetts Department of Revenue continues to evaluate the core definitions of § 38M through the lens of the 1991 standards unless specific state regulations provide otherwise.6

Defining Qualified Research and Expenses in the Commonwealth

To qualify for the credit, a corporation must engage in activities that meet the four-part test derived from federal standards but applied in a Massachusetts context. These activities must be technological in nature, aimed at a permitted purpose, intended to eliminate technological uncertainty, and involve a process of experimentation.9 The requirement that research be technological in nature implies that the activity must fundamentally rely on principles of physical or biological sciences, engineering, or computer science. Activities that focus on social sciences, arts, or humanities do not meet this threshold, nor do activities focused on style, taste, or cosmetic design.12

The permitted purpose aspect of the test requires that the research be intended to improve the function, performance, reliability, or quality of a new or existing business component. This component can be a product, process, computer software, technique, formula, or invention to be held for sale, lease, or license, or used by the taxpayer in its own trade or business.10 In Massachusetts, this often translates to the development of complex medical devices, new pharmaceutical formulations, or proprietary software architectures that drive financial services.4

The elimination of uncertainty and the process of experimentation are the most rigorously audited components of the definition. Taxpayers must demonstrate that they encountered uncertainty regarding the capability or method for achieving a desired result, or the appropriate design of that result, at the outset of the project. The process of experimentation must involve a systematic evaluation of alternatives, such as through modeling, simulation, or systematic trial and error, to resolve that uncertainty.12 In the high-stakes environment of Massachusetts biotech labs or software incubators, this often involves extensive documentation of failed prototypes and iterative testing cycles.9

Categorization of Qualified Research Expenses (QREs)

Under § 38M and the governing regulation 830 CMR 63.38M.1, QREs are categorized into four primary types, all of which must be attributable to Massachusetts-based operations. The distinction between in-state and out-of-state expenses is paramount, and the Department of Revenue provides strict guidance on how these costs must be captured and reported.5

Wages paid for qualified services performed in the Commonwealth constitute the largest share of QREs for most firms. This includes salaries and wages paid to employees who are directly engaged in qualified research, as well as those who provide direct supervision or support. Direct support might include a lab technician preparing samples or a programmer coding a test suite, while direct supervision includes a lead scientist or project manager overseeing the experimental process.2 If an employee’s services are performed both within and without Massachusetts, the wages must be prorated. This is typically calculated based on the ratio of the number of days the service provider was used in Massachusetts to the total number of days employed.8 For corporations with remote or hybrid workforces, this necessitates a robust time-tracking system to ensure that only the portion of the wage reflecting work performed at a Massachusetts location—be it a company office or a residential home office within state lines—is included in the credit base.8

Supplies used in qualified research are the second major category. This covers amounts paid for tangible property used or consumed in the research process. It specifically excludes land, improvements to land, and property of a character subject to the allowance for depreciation. The supplies must be used to conduct research in Massachusetts.7 For instance, chemical reagents, prototype components, and specialized lab materials are qualifying supplies, whereas the cost of a centrifuge or a permanent cleanroom facility would be treated as capital equipment subject to depreciation and potentially eligible for the separate Investment Tax Credit (ITC) rather than the § 38M research credit.12

Computer rental and time-sharing fees represent a specialized category. Costs paid for the right to use computers for research purposes are eligible, provided the computers are physically located in Massachusetts.2 This category has become increasingly complex with the advent of cloud computing. While the 1991 IRC standards focused on physical mainframes and time-sharing agreements, modern Massachusetts guidance typically looks to the physical location of the server infrastructure. If a firm pays for server capacity at a data center located in Springfield, Massachusetts, those costs are generally qualifying, whereas fees paid to a cloud provider with data centers exclusively in Virginia would not qualify under the strict geographic requirements of § 38M.2

Contract research expenses allow for the inclusion of 65% of the amounts paid to third parties for qualified research conducted on the taxpayer’s behalf. Crucially, the research facility where the contractor performs the work must be located within Massachusetts.2 This requirement ensures that the state incentive benefits the broader Massachusetts research ecosystem, including universities and contract research organizations (CROs). For example, a Cambridge-based startup that contracts with a University of Massachusetts lab for testing is eligible to include 65% of those payments in its credit calculation, provided the university lab is located in the Commonwealth.9

Calculation Methodologies: Traditional vs. ASM

Taxpayers currently have two primary pathways to calculate the research credit, identified as the Traditional Method (Option 1) and the Alternative Simplified Method (Option 2). The choice of method can significantly impact the final credit amount and must be made at the time of filing.6

The Traditional Method (Option 1)

The Traditional Method, based on § 38M(a), calculates the credit as 10% of the excess of current-year QREs over a base amount, plus 15% of basic research payments.1 The base amount is the product of the taxpayer’s average annual gross receipts for the four taxable years preceding the credit year and a fixed-base ratio. The fixed-base ratio is determined by the relationship between R&D spending and gross receipts during a specific historical period—generally 1984 to 1988.1 For established corporations, this ratio is calculated once and remains constant, whereas for start-up companies, the law provides a sliding scale of fixed percentages that evolve over the first decade of the company’s existence.10

The mathematical representation of the Traditional Method follows a specific logic. The base amount is calculated as follows:

$$Base\ Amount = Average\ Receipts_{4-year} \times Fixed\text{-}Base\ Ratio$$

However, the law imposes a floor on this calculation. The base amount cannot be less than 50% of the current year’s QREs.1 This ensures that even firms with very low historical R&D intensity cannot claim a credit on their entire R&D budget; the credit is strictly targeted at the incremental growth in R&D activity. The fixed-base ratio itself is capped at 16% to prevent outlier companies with extreme historical spending from skewing the state’s fiscal obligations.1

The 15% add-on for basic research payments is an additional incentive specifically for payments made to qualified non-profit organizations, such as universities or scientific research groups. These payments must be for the advancement of scientific knowledge without a specific commercial objective.1 This component reflects the state’s commitment to bridging the gap between academic discovery and commercial development.

The Alternative Simplified Method (Option 2)

Introduced for tax years beginning on or after January 1, 2015, the ASM (under § 38M(b)) was designed to mirror the federal ASM, providing a simpler calculation that focuses on more recent R&D history. This method is mandatory for taxpayers who had zero gross receipts for the third and fourth preceding years and optional for others.5

The ASM calculation has been phased in with increasing rates over the last decade, reflecting a policy shift toward making the credit more accessible to high-growth tech firms that might not have a historical record dating back to the 1980s. Between 2015 and 2017, the rate was 5%; from 2018 to 2020, it was 7.5%; and for calendar years beginning on or after January 1, 2021, the rate reached its full 10%.1

The base amount for the ASM is 50% of the average QREs for the three preceding taxable years. If a taxpayer did not have QREs in any one of the three preceding years, the credit is reduced to 5% of the total current-year QREs.1 This methodology rewards consistent year-over-year growth in research investment without requiring the extensive historical documentation needed for the Traditional Method.

Strategic Considerations for Calculation Methods

Choosing between the Traditional Method and the ASM is a significant tax strategy decision for Massachusetts corporations. The Traditional Method is often more beneficial for companies with a long history of R&D activity in the state and high current revenues, as the fixed-base ratio can result in a lower base amount relative to current QREs. However, the requirement to maintain records from the 1984-1988 period can be an insurmountable barrier for many firms.2

The ASM is generally preferred by high-growth startups and established firms that have significantly increased their R&D footprint in Massachusetts recently. Since the ASM base amount is tied to recent QREs rather than gross receipts, it is more insulated from fluctuations in the company’s sales. The ASM election is intended to be a longer-term choice and generally should not be changed from year to year without strong justification and consultation with tax advisors, as frequent flipping between methods can trigger increased audit scrutiny from the Department of Revenue.2

Utilization Limitations and the Minimum Tax Floor

The Massachusetts Research Credit is characterized as a non-refundable credit, meaning it can reduce a taxpayer’s excise liability but cannot result in a refund check from the Commonwealth, except under specific certified programs.1 The utilization of § 38M credits is governed by two major restrictions designed to ensure that the Commonwealth maintains a minimum level of revenue from every profitable corporation.

First, the excise limit applies a two-tiered threshold. The credit can offset 100% of the first $25,000 of corporate excise due. For any excise liability exceeding $25,000, the credit is limited to offsetting only 75% of that excess amount.2 This structure ensures that large profitable corporations with millions of dollars in credits still pay a meaningful amount of tax to the state. Second, the minimum excise rule provides that regardless of the number of credits a corporation holds, the excise cannot be reduced below the statutory minimum of $456.2

Carryover Provisions and the Indefinite Rule

Credits that cannot be used in the current year due to these limitations do not expire immediately, but they are categorized into two distinct buckets for carryover purposes. A standard 15-year carryover applies to credits that exceed the taxpayer’s total liability for the year. These may be carried over for the next 15 succeeding taxable years, after which any remaining balance is lost.3

However, the law provides a more generous indefinite carryover for credits that were disallowed specifically because of the 75% limitation rule. Credits disallowed under the 75% limitation—which essentially represents 25% of the excise exceeding $25,000—may be carried forward for an unlimited period of time. This provision prevents the permanent loss of credits for high-liability taxpayers and provides long-term value for firms making sustained R&D investments in the state.2

The Department of Revenue requires corporations to maintain detailed records to track these different carryover buckets. In the case of combined groups, unused credits must be tracked by the individual corporation that generated them, though they may be applied against the liability of other group members under certain conditions. This tracking is particularly important during mergers and acquisitions, where the survival of credits depends on the specific structure of the transaction.3

Aggregation and Controlled Groups

Section 38M(a) and the associated regulation 830 CMR 63.38M.2(9) mandate the aggregation of research activities for controlled groups. All corporations under common control, as defined by IRC § 41(f), must be treated as a single taxpayer for the purposes of calculating the credit. This prevents companies from artificially splitting their operations into multiple entities to maximize the $25,000 threshold or to manipulate their fixed-base ratios.1

The aggregation process involves summing all QREs and basic research payments of all group members, while eliminating inter-company payments. A single group credit is calculated based on these aggregated totals. This group credit is then allocated back to the individual members based on their proportionate share of the total group QREs.6 For corporations filing a combined return under § 32B, the individual members first apply their share of the credit against their own attributable excise. If a member has excess credits, it may share those credits with other members of the combined group, provided the receiving member has sufficient liability remaining under the 75% limitation rule.3

This aggregation rule applies to all entities under common control, whether or not they are incorporated. This includes partnerships, LLCs, and joint ventures. For unincorporated flow-through entities, the credit-relevant amounts are attributed to the owners, who then take them into account when determining their own credit for the taxable year.10

Special Entity Rules: S Corporations and Partnerships

The application of § 38M to S corporations and other pass-through entities contains nuances that differ from the federal treatment. S corporations in Massachusetts may apply the § 38M credit against their own corporate excise liability. This includes the non-income measure, which is based on property or net worth, and if applicable, the income measure for S corporations with total receipts exceeding certain thresholds.2

However, the § 38M credit does not flow through to the individual shareholders of an S corporation. This is a critical distinction from many other Massachusetts credits and from the federal research credit, where the benefit typically passes to the owners’ personal tax returns. In Massachusetts, the credit remains at the entity level to offset the S corporation’s specific excise obligations.2 For partnerships and LLCs treated as partnerships, the credit is attributed to the partners or members. If the partner is a corporation, it claims the credit against its corporate excise; if the partner is an individual, they claim it against their personal income tax under MGL c. 62, provided the research was conducted in Massachusetts.2

The Life Sciences and Climatetech Ecosystem

Massachusetts has created specialized ecosystems for companies in the life sciences and climatetech sectors, allowing them to monetize R&D credits even when they are not yet profitable. These programs recognize the long development cycles and high capital requirements of these industries.

Life Sciences Refund Election

Under the Life Sciences Tax Incentive Program, certified life sciences companies may apply to the Massachusetts Life Sciences Center (MLSC) for a refund of excess § 38M research credits. If authorized, a company can receive a refund equal to 90% of its unused credit balance for the year.1 This is essentially a cash payment from the state, providing vital liquidity to pre-revenue biotech firms.

It is important to distinguish the § 38M general research credit from the § 38W Life Sciences Research Credit. While § 38M is the general credit available to all corporations, § 38W is a separate credit specifically awarded by the MLSC. Companies cannot double-dip by claiming both credits for the same dollar of expenditure. The MLSC determines which credit is most appropriate for a certified company, and § 38W claims do not require the filing of Schedule RC but are instead reported on the Credit Manager Schedule (CMS) with a unique certificate number.7

2024 Climatetech Expansion

Reflecting the state’s latest economic priorities, the law was significantly expanded by St. 2024, c. 238, effective November 20, 2024. These amendments introduced a climatetech tax incentive program that mirrors the life sciences model.1 Certified climatetech companies—defined as those developing technologies to reduce greenhouse gas emissions or adapt to climate change—are now eligible for the 90% refund of unused § 38M credits if authorized by the climatetech incentive program established under chapter 23J.1 This represents a strategic effort to build a second world-class innovation cluster in the Commonwealth, focusing on the green economy.

Impact on Net Income and the Add-Back Rule

A technical but essential aspect of the credit is its effect on the taxpayer’s net income calculation. In determining net income for Massachusetts tax purposes, the deduction for research expenses otherwise allowable must be reduced by the amount of the § 38M credit determined for the year.5

This add-back rule is codified in MGL c. 63, § 30.4 and ensures that the corporation does not receive a double benefit—both a tax deduction and a tax credit—for the same expenditure. Taxpayers must calculate the credit first and then adjust their Schedule E or U-E deductions accordingly. This mirrors the federal requirement under IRC § 280C(c), but it must be applied specifically to the Massachusetts credit amount generated.5

Financial Institutions and the State Street Decision

One of the most significant shifts in the history of § 38M occurred in late 2024 and early 2025 following the Appellate Tax Board’s decision in State Street Corporation v. Commissioner of Revenue.4

Historically, the Department of Revenue had maintained that the § 38M credit was only available to business corporations taxed under § 39, which excluded financial institutions taxed under § 2. The Board disagreed, ruling that the definition of a business corporation under MGL c. 63, § 30(1) was broad enough to include financial institutions. This decision opened the door for banks, investment firms, and other financial entities to claim the credit for their extensive internal software development and data analytics research.4

In response, the DOR issued Technical Information Release (TIR) 25-3, formally conceding the point. The TIR clarifies that all business corporations subject to an excise under Chapter 63 are eligible for the credit. Perhaps more importantly, the TIR allows financial institutions to file amended returns or abatement applications to claim credits for prior years, and it even allows the election of the Alternative Simplified Method on these amended returns—a choice previously restricted to original filings.16 This development is expected to result in a significant surge in credit claims from the financial services sector in Boston and beyond.

Defense-Related Activities Election

Section 38M(j) provides a specialized election for corporations involved in defense-related activities. Taxpayers may elect to calculate the credit separately for their defense-related research and their other qualified research. This can be advantageous if the company’s defense business has a different R&D intensity or growth profile than its commercial business.1

Defense-related activities are broadly defined to include the research, development, and production of arms, ammunition, and implements of war designated on the munitions list. Recent updates have expanded this to include medicines and medical supplies used to treat threats from chemical, biological, or nuclear agents, as well as vaccines and antibodies.3 To make this election, the corporation must file separate Part 1 calculations on Schedule RC for defense and non-defense activities, combining the results on the Credit Manager Schedule.6

Administrative Compliance: Schedule RC and Audits

The primary mechanism for claiming the credit is Schedule RC (Research Credit), which must be filed as part of the corporate excise return. For members of an aggregated group, Schedule RC-A may also be required to substantiate the group-wide calculation and the subsequent allocation of credits to individual members.6

The Department of Revenue maintains a rigorous audit posture regarding the R&D credit. Taxpayers are expected to maintain records that substantiate every dollar of qualifying expense and every hour of qualifying labor. This includes time-tracking logs, project descriptions, lab notebooks, and proof of the physical location where the research was conducted.9 Inadequate records can lead to the disallowance of the entire credit. Furthermore, because the credit is based on the 1991 federal standards, auditors may challenge interpretations that rely on more recent, more lenient federal guidance that hasn’t been formally adopted by the Commonwealth.2

Statistical Overview and Fiscal Impact

The § 38M credit is one of the most significant tax expenditures in the Massachusetts budget. According to the Department of Revenue’s Tax Expenditure reports, the cost of the credit has grown steadily, reflecting the state’s increasing reliance on innovation as an economic driver.

In Fiscal Year 2021, the estimated cost of the corporate excise R&D credit was $279.6 million. By Fiscal Year 2024, this had grown to an estimated $344.0 million, and the projections for Fiscal Year 2025 exceed $359 million.11 This growth is consistent with the increasing concentration of venture capital and federal research grants flowing into the Commonwealth.

Total net state tax revenues for FY 2024 were approximately $39.5 billion, with corporations contributing $4.23 billion. The R&D credit represents about 8% of total corporate excise potential, illustrating its profound role in the state’s fiscal landscape.21

Comprehensive Calculation Example: BioGenius Technologies Inc.

To illustrate the interplay of these complex rules, consider the case of BioGenius Technologies Inc., a mid-sized Massachusetts-based biotech firm, filing for the 2024 tax year.

Phase 1: Identifying Massachusetts QREs

BioGenius conducted research on a new oncology drug in its lab in Worcester and its headquarters in Cambridge. Its total expenses for the year were as follows:

• Qualified Wages: $2,000,000 paid to researchers located in Massachusetts.
• Qualified Supplies: $500,000 for chemicals and specialized reagents used in-state.
• Contract Research: $400,000 paid to a Massachusetts-based clinical research organization (CRO).
• Basic Research Payment: $100,000 paid to the University of Massachusetts Medical School for fundamental cellular research.

Total Current QRE Calculation:

1. Wages: $2,000,000
2. Supplies: $500,000
3. Contract Research (65% of $400,000): $260,000
4. Total QREs: $2,760,000.6

Phase 2: Choosing a Calculation Method

BioGenius is an established firm with a long history. It evaluates both methods.

Option 1: Traditional Method

• Average Gross Receipts (Last 4 Years): $20,000,000.
• Fixed-Base Ratio (based on 1980s data): 8.00%.
• Step 1: Base Amount = $20,000,000 $\times$ 0.08 = $1,600,000.
• Step 2: Floor Check = 50% of current QREs ($2,760,000) = $1,380,000.
• Resulting Base: $1,600,000 (since $1.6M > $1.38M).
• Step 3: Incremental Credit = 10% $\times$ ($2,760,000 – $1,600,000) = $116,000.
• Step 4: Basic Research Add-on = 15% $\times$ $100,000 = $15,000.
• Total Traditional Credit: $131,000.1

Option 2: Alternative Simplified Method (ASM)

• Average QREs (Last 3 Years): $2,200,000.
• Step 1: Base Amount = 50% of $2,200,000 = $1,100,000.
• Step 2: Incremental Credit = 10% $\times$ ($2,760,000 – $1,100,000) = $166,000.
• Note: Basic research add-on is not available under ASM.2

BioGenius elects the ASM for a credit of $166,000.

Phase 3: Applying Utilization Limitations

BioGenius has a total corporate excise liability for the year of $150,000.

1. First $25,000 of excise: 100% offset = $25,000 credit used.
2. Excise over $25,000: ($150,000 – $25,000) = $125,000.
3. 75% Limit: 75% of $125,000 = $93,750 credit used.
4. Total Credit Used: $25,000 + $93,750 = $118,750.
5. Final Tax Liability: $150,000 – $118,750 = $31,250.2

Phase 4: Carryover and Adjustments

• Excess Credit Generated: $166,000 (total generated) – $118,750 (used) = $47,250.
• Indefinite Carryover Bucket: The portion disallowed by the 75% rule ($125,000 $\times$ 25%) = $31,250. This can be carried forward indefinitely.7
• 15-Year Carryover Bucket: The remaining unused portion ($47,250 – $31,250) = $16,000. This must be used within 15 years.7
• Income Tax Adjustment: BioGenius must add back $166,000 to its taxable net income on Schedule E.5

Conclusion

The Massachusetts Research and Development Tax Credit under MGL c. 63, § 38M is a sophisticated fiscal tool that requires a nuanced understanding of both historical federal standards and current state-level administrative guidance. By offering a choice between the Traditional Method and the Alternative Simplified Method, the Commonwealth provides a flexible incentive structure that accommodates both established industrial giants and fast-moving technological startups. The recent expansion of eligibility to financial institutions and the inclusion of climatetech companies in the refundability framework signal that the state continues to view this credit as its primary weapon in the competition for global talent and capital.

However, the complexity of the credit—particularly regarding the aggregation of controlled groups, the geographic proration of labor, and the tiered utilization caps—means that businesses must treat it as a multi-year strategic commitment rather than a simple annual filing. Success in claiming and retaining the credit depends on a rigorous documentation culture and a proactive tax strategy that anticipates shifts in Department of Revenue policy and judicial interpretation. As Massachusetts continues to pivot toward a green and data-driven economy, the § 38M credit will undoubtedly remain the cornerstone of its corporate incentive portfolio.

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