Comprehensive Analysis of Supplies Used or Consumed Under the Massachusetts Research and Development Tax Credit

In the regulatory framework of the Massachusetts Research and Development (R&D) tax credit, “supplies used or consumed” refers to non-depreciable tangible personal property, such as chemical reagents or prototype materials, physically utilized within the Commonwealth for qualified research activities. This definition specifically excludes land, land improvements, and any property of a character subject to an allowance for depreciation under Section 167 of the Internal Revenue Code. 1

The Statutory Foundation of the Massachusetts Research Credit

The Massachusetts Research and Development Tax Credit, codified in Massachusetts General Laws Chapter 63, Section 38M, serves as a cornerstone of the Commonwealth’s strategy to foster a high-innovation economy. 5 The credit provides a significant incentive for business corporations to invest in scientific and technological advancement within the state’s borders. 7 While many state tax incentives operate in isolation, the Massachusetts R&D credit is intentionally designed to parallel the federal research credit available under Internal Revenue Code (IRC) Section 41. 1 This alignment ensures that corporations can streamline their compliance efforts, though the state-level application introduces unique geographic and administrative requirements that demand careful attention from tax professionals. 7

Under Section 38M, eligible corporations are granted a credit against their corporate excise tax equal to the sum of 10 percent of the excess of qualified research expenses (QREs) for the taxable year over a base amount, plus 15 percent of basic research payments. 6 The “base amount” is a calculated threshold designed to ensure that the credit rewards incremental investment rather than baseline spending. 1 Within this calculation, the definition of qualified research expenses is critical, as it determines the pool of costs that can effectively reduce a corporation’s tax liability. 7 These expenses are categorized into three primary streams: wages for researchers, a portion of contract research expenses, and the cost of supplies used or consumed in the research process. 8

The interaction between state law and the federal code is governed by specific “conformity dates.” 6 For the traditional calculation method, Massachusetts adopts the definitions of IRC Section 41 as they existed on August 12, 1991. 2 For taxpayers electing the Alternative Simplified Method (ASM), the definitions generally conform to the IRC as of January 1, 2014. 1 This dual-track conformity requires practitioners to be aware of subtle shifts in federal law that may or may not be reflected in the state’s current interpretation. 14 Despite these varying dates, the fundamental definition of what constitutes a “supply” remains largely consistent: it must be tangible, it must be used in research, and it must not be a capital asset. 4

Definitional Parameters of Supplies Under IRC Section 41(b)(2)(C)

To understand the Massachusetts definition of supplies, one must first analyze the federal definition provided in IRC Section 41(b)(2)(C), which the Commonwealth explicitly adopts through Section 38M. 1 The federal code defines supplies as any tangible property other than land or land improvements and property of a character subject to the allowance for depreciation. 1 This definition establishes a clear boundary between immediate operational inputs and long-term capital investments, a distinction that is frequently tested during audits by the Department of Revenue (DOR). 4

The requirement for property to be “tangible” excludes intangible assets such as intellectual property rights, patents, or software licenses from being classified as supplies. 4 While software development is a massive component of the Massachusetts economy, the “supplies” category for a pure software firm is often minimal, as the primary inputs are human capital (wages) and computing power. 3 However, for companies engaged in hardware-software integration, such as robotics or medical device manufacturing, the tangible components used to build physical prototypes—ranging from microchips to specialized alloys—fall squarely within the definition of supplies. 4

The exclusion of “depreciable property” is perhaps the most significant constraint. 3 Under Section 167 of the Code, property is depreciable if it has a limited useful life and is used in a trade or business or held for the production of income. 4 This means that laboratory equipment, computers, machinery, and tools that have a useful life beyond one year cannot be claimed as research supplies, even if they are used exclusively for research. 4 Instead, these items may be eligible for the Massachusetts Investment Tax Credit (ITC) under M.G.L. c. 63, § 31A, which provides a 3 percent credit for qualifying tangible property used in research and development or manufacturing. 22 The R&D credit and the ITC are mutually exclusive for the same expenditure; a corporation cannot claim an item as both a non-depreciable supply and a depreciable capital asset. 22

Geographic Nexus: The “In Massachusetts” Requirement

The most critical divergence between the federal R&D tax credit and the Massachusetts state credit is the requirement for local utilization. 7 While the federal credit applies to research conducted anywhere within the United States, the Massachusetts credit is strictly limited to activities and expenses incurred for research conducted “within Massachusetts.” 2 For supplies, this means the materials must be physically “used or consumed in Massachusetts.” 1

This geographic mandate creates an administrative necessity for taxpayers to track the physical location of their research inputs. 25 In many modern R&D organizations, research is a cross-border endeavor. A company might procure raw materials in one state, process them in another, and test them in a third. 28 Under Massachusetts law, only the portion of supply costs associated with the activity occurring in the Commonwealth is eligible for the credit. 25 If a corporation utilizes supplies both inside and outside of Massachusetts, it must employ a reasonable method of proration to determine the amount of expenses allocable to the Commonwealth. 27

The Department of Revenue provides specific guidance on proration in the context of services and tangible property. 27 Generally, expenses that pertain to property used both inside and outside the state must be prorated in proportion to the ratio of the number of days the property was used in Massachusetts to the total number of days the property was employed. 27 For consumable supplies that are destroyed or integrated in-state, the analysis is simpler: the total cost is eligible if the consumption event occurred within the state’s borders. 1 However, for materials used in ongoing experiments that move between facilities, the record-keeping burden increases, requiring detailed logs to substantiate the state-level claim during a DOR audit. 9

Analysis of Local State Revenue Office Guidance and Technical Information Releases

The Massachusetts Department of Revenue (DOR) issues various forms of guidance to interpret the law, including Technical Information Releases (TIRs), Letter Rulings (LRs), and Administrative Procedures (APs). 7 These documents provide essential clarity on how the high-level statutory language of Section 38M applies to the nuanced reality of business operations. 11

TIR 14-13 and TIR 14-16: The 2014 Reforms

TIR 14-13 was issued following the enactment of “An Act Promoting Economic Growth Across the Commonwealth,” which substantially revised Section 38M effective for tax years beginning on or after January 1, 2015. 11 This release explained the introduction of the Alternative Simplified Method (ASM) for calculating the credit. 11 Importantly, it reiterated that the definition of qualified research expenses—including supplies—remained largely unchanged in substance but introduced a new conformity date for those electing the ASM. 6

TIR 14-16 followed shortly after to provide technical corrections. 15 It clarified the phase-in rates for the ASM, which reached its full 10 percent rate in 2021. 6 For a corporation determining its supply costs under the ASM, the technical corrections in TIR 14-16 emphasized that the 50 percent look-back period (used to determine the base) must also consistently categorize expenses as supplies to ensure an “apples-to-apples” comparison. 11 If a corporation historically treated certain prototype costs as capital expenditures but now seeks to treat them as supplies, it must adjust its base period data to maintain consistency. 11

TIR 25-3: The State Street Decision and Financial Institution Eligibility

A transformative development in Massachusetts tax law occurred with the 2024 Appellate Tax Board decision in State Street Corporation v. Commissioner of Revenue. 31 Historically, the DOR had maintained that the R&D credit was only available to general corporations subject to the corporation excise. 33 The Board, however, held that the plain language of the statute allows all business corporations, including financial institutions, to claim the credit. 31

TIR 25-3, issued in May 2025, outlines the Department’s acceptance of this ruling. 7 This has profound implications for the “supplies” category. Banks and financial service firms often engage in significant R&D related to security, high-frequency trading, and data processing. 34 Under TIR 25-3, these entities can now include the cost of tangible, non-depreciable property used in their research. 33 While much of their R&D is software-based, the hardware components used in “sandbox” environments or experimental server configurations—provided they are not capitalized—may now qualify as research supplies for the first time in Massachusetts history. 31

TIR 25-5: Climatetech and Future Innovations

The most recent legislative updates, explained in TIR 25-5, discuss the “Economic Development Act” and its impact on the climatetech sector. 30 The act creates new climatetech-specific incentives, including a Climatetech Qualified Research Expenses Credit. 36 This credit follows the same calculation methodology and definitions as the general Section 38M credit. 36 For companies developing new solar cell chemistries or wind turbine materials in Massachusetts, the supply definition remains the same: the materials must be non-depreciable and physically used within the state. 36 This highlights the state’s continued reliance on the Section 38M framework to drive industry-specific growth. 20

Sector-Specific Application: Life Sciences and Clinical Trials

Massachusetts is a global leader in the life sciences sector, and the Department of Revenue has provided extensive guidance on how the “supplies used or consumed” rule applies to biotechnology and pharmaceutical research. 7 In this industry, the cost of materials—ranging from rare chemical compounds to specialized biological agents—can be a massive component of the R&D budget. 4

One of the most complex areas involves expenditures for clinical trials. 25 Under 830 CMR 64H.6.4, expenditures incurred in conducting clinical trials in Massachusetts are specifically included in the numerator for the expenditures test used to qualify as an R&D corporation. 25 For the research credit, supplies used in clinical trials follow the same principle: they must be used or consumed in Massachusetts. 25 This creates a significant hurdle for Massachusetts-headquartered firms whose trials often take place across national or international networks of hospitals and clinics. 25

The DOR’s position is that even if a trial is managed, directed, and initiated from a headquarters in Cambridge, the materials consumed during a trial in Ohio are not “used in Massachusetts.” 25 However, the in-state costs of employees supervising those trials are includable. 25 This creates a fragmented tax picture where a single research project’s wages might qualify for the credit, but its supplies do not, simply because of the physical location of the patient administration. 25

Letter Ruling 11-5 provides an illustrative case involving pharmaceutical compounds. 28 In this instance, a company had its compounds processed and placed in vials (“fill/finish”) in Massachusetts. 28 The compounds were then shipped outside the Commonwealth for administration in clinical trials. 28 While the ruling focused on Sales and Use Tax exemptions, it clarified the “subsequently transported outside the Commonwealth” exception. 28 For the R&D credit, if those compounds are consumed (i.e., administered to a patient) outside Massachusetts, they generally do not count as a supply QRE for the Section 38M credit, regardless of where they were packaged. 25

Sector-Specific Application: Defense and Biodefense Expansion

Effective for the 2024 tax year, the Massachusetts legislature expanded the definition of “defense-related activities” to include a wider range of medical and biological research. 1 This expansion is significant because taxpayers may elect to calculate the credit for defense-related activities separately from other activities, potentially optimizing their base amount and credit yield. 1

The updated definition of defense-related activities now includes research into:

• Medicines and medical supplies used to diagnose, prevent, or treat diseases related to chemical, biological, radiological, or nuclear (CBRN) threats. 1
• Biologic products, vaccines, blood products, and antibodies. 1
• Antimicrobial or antiviral drugs and diagnostic tests used to identify threat agents. 1
• Personal protective equipment (PPE). 1

This legislative shift recognizes that the modern defense industry involves not just traditional weaponry, but also sophisticated biological and medical research. 1 For companies in these fields, the supplies—such as experimental vaccines or specialized filtration materials for PPE—are explicitly brought into the “defense-related” calculation, provided they are used or consumed within Massachusetts facilities. 1

Distinguishing Supplies from Inventory and Capital Assets

One of the primary challenges during a Department of Revenue audit is the classification of materials that occupy a “gray area” between research supplies and either commercial inventory or depreciable capital assets. 4

Supplies vs. Inventory

Materials that are incorporated into a product intended for sale are typically classified as inventory rather than research supplies. 17 However, the IRC and Massachusetts law recognize that the “ultimate success, failure, sale, or use of the supply used in the research is not relevant in determining its eligibility for the credit.” 17 If a prototype is built for the primary purpose of testing and experimentation, its material costs may qualify as supplies even if that prototype is eventually sold to a customer. 17

The burden of proof rests on the taxpayer to demonstrate that the original intent of the expenditure was for research. 9 If a company purchases a batch of raw materials and uses half for R&D and half for production, it must have a robust accounting system to segregate those costs. 17 Failure to maintain “contemporaneous documentation” often leads the DOR to disqualify these expenses during an audit, categorizing them as general production costs rather than qualified research expenses. 9

Supplies vs. Capital Assets

The distinction between an expensed supply and a capitalized asset is governed by the taxpayer’s accounting methods and federal tax law. 4 As noted previously, any item subject to depreciation is not a supply. 4 This includes “self-constructed assets.” 4 If a company uses its own labor and materials to build a piece of testing equipment that it then uses for several years, that equipment must be capitalized. 4 The materials used to build that equipment are not considered “research supplies” for the R&D credit because the resulting asset is depreciable. 4

However, the “pilot model” rule allows for certain costs to be treated as research expenses. 18 A pilot model is a prototype that is produced to test a concept or design. 18 If the pilot model is used for testing and then discarded or kept only as a non-functional reference, the materials used to build it are qualifying supplies. 4 The critical factor is whether the asset is of a character subject to depreciation in the hands of the taxpayer. 4

The Impact of Section 174 Capitalization on the Research Credit

A major shift in the tax landscape occurred with the implementation of the Tax Cuts and Jobs Act (TCJA) and its subsequent influence on state-level tax treatment. 3 Effective for tax years beginning on or after January 1, 2022, IRC Section 174 requires companies to capitalize and amortize their research and experimental (R&E) expenditures over five years (for domestic research) or fifteen years (for foreign research). 3

This capitalization requirement is distinct from the R&D tax credit available under Section 41. 3 While the credit rewards a subset of direct costs (wages, supplies, contract research), Section 174 covers a much broader range of both direct and indirect costs. 18 In Massachusetts, the Department of Revenue generally conforms to the Internal Revenue Code for corporate tax purposes. 13 Recent legislative updates, such as the “One Big Beautiful Bill Act” (OBBBA) discussed in Massachusetts tax circles, have introduced opportunities for small businesses to retroactively adopt full expensing for certain R&D costs for 2022-2024, though the standard capitalization rules for Section 174 remain a significant factor for larger corporations. 13

For supply expenses, this means that even though a corporation may receive a 10 percent credit on its Massachusetts return for the cost of research supplies, it may still be required to amortize the remaining 90 percent of those costs over five years rather than deducting them immediately. 3 This decoupling of the credit and the deduction highlights the complexity of modern R&D tax planning, where “supplies used or consumed” must be tracked not only for the credit but also for mandatory capitalization. 3

Illustrative Example: The Hybrid Medical-Defense Project

To visualize the application of these rules, consider a hypothetical corporation, QuantumSurgical, LLC, based in Worcester, Massachusetts. The company is developing a new type of robotic surgical arm that can be used in field hospitals for treating chemical-agent exposure—a project that qualifies as both general research and a “defense-related activity” under the 2024 definition. 1

Project Expenditures in 2024

• Raw Materials: $200,000 for high-grade titanium and specialized glass used to build three non-depreciable prototypes. All prototypes are built and tested at the Worcester facility. 4
• Electronic Sensors: $50,000 for experimental sensors used to detect nerve agents. These sensors are integrated into the prototypes and consumed during destructive testing. 17
• Laboratory Reagents: $15,000 for chemicals used to test the sensors’ accuracy against simulated agents. 4
• Cloud Computing: $40,000 paid to an external provider for high-performance computing time to simulate surgical movements. 2
• Manufacturing Machinery: $120,000 for a new CNC machine used exclusively to mill the prototype parts. 4
• Out-of-State Testing: $30,000 for materials used in a final field test conducted at a facility in Virginia. 9

Analysis of Qualified Research Expenses (QREs)

1. Qualifying Supplies (In Massachusetts): The titanium, glass, sensors, and reagents used in Worcester are all qualifying supplies. They are tangible, non-depreciable, and used in Massachusetts. Total Supply QREs = $200,000 + $50,000 + $15,000 = $265,000. 1
2. Computer Rental Time: The $40,000 for cloud computing is a qualifying research expense, but it is not a “supply.” It is reported as “qualified computer rental time” on Line 3 of Schedule RC. 1
3. Capital Asset (Disqualified as Supply): The $120,000 CNC machine is depreciable property. It cannot be claimed as a supply for the R&D credit. However, QuantumSurgical may claim a 3 percent Investment Tax Credit ($3,600) for this machine under M.G.L. c. 63, § 31A. 22
4. Out-of-State Materials (Disqualified): The $30,000 used in Virginia fails the “used or consumed in Massachusetts” test. These costs are excluded from the Massachusetts credit calculation. 12

Impact of the “Defense-Related” Election

Because the project involves “medical supplies… used to treat diseases related to chemical… threats,” QuantumSurgical can elect to calculate the credit for these expenses separately. 1 This separate calculation can be advantageous if the company’s base period for defense activities is lower than its general base period, effectively allowing for a higher credit yield on the $265,000 of in-state supplies. 1

Statistical Overview and Economic Significance of the Research Credit

The Research and Development Tax Credit is one of the Commonwealth’s most significant “tax expenditures”—statutory provisions that represent revenue foregone by the state to support policy objectives. 44 The scale of this investment is reflective of the state’s reliance on high-tech sectors to drive its overall economic performance. 45

According to the Massachusetts Tax Expenditure Budget reports, the cost of the research credit has seen steady growth, paralleling the recovery of the innovation economy following the global pandemic. 32 For corporations, the credit is the largest single category of corporate excise tax expenditures. 32

This fiscal data, sourced from the Governor’s FY 2025 Budget Recommendation, demonstrates that the research credit accounts for approximately 18 percent of all corporate excise tax benefits provided by the state. 32 The projected increase to $644.6 million for FY 2025 highlights the continued demand for this incentive and the high volume of research activity being conducted within the Commonwealth. 32

The economic impact of this spending is visible in the state’s primary metrics. Massachusetts consistently ranks at the top of the nation for per capita income ($93,927 in 2024) and receives billions in venture capital investment annually—third in the nation as of 2023. 45 The R&D credit, and specifically the broad allowance for supply and wage expenses, provides the necessary cash flow for companies to maintain this pace of innovation. 9

Limitations on the Utilization of the Credit

While the credit amount is calculated as 10 percent of excess QREs, there are significant statutory caps on how much of that credit can be used in a single tax year. 6 These limitations are designed to ensure that the state maintains a baseline level of corporate revenue. 7

The credit is limited to:

• 100 percent of a corporation’s first $25,000 of corporate excise liability. 6
• 75 percent of the excise liability in excess of $25,000. 6
• The credit cannot reduce the excise below the minimum tax of $456. 7

For many high-growth companies, particularly in the life sciences and tech sectors, the credit generated often far exceeds these limitations. 7 In such cases, the law provides for a generous carryforward period. 6 Any portion of the credit disallowed because of the 75 percent limitation may be carried forward indefinitely. 7 Other unused credits may be carried forward for up to 15 years. 6 This ensures that the value of the research supplies “used or consumed” today can be realized even as the company scales and becomes profitable in future years. 7

Accounting Best Practices and Audit Defense for Supply Claims

Given the complexity of the “used or consumed” definition and the strict geographic requirements, the Massachusetts Department of Revenue frequently audits research credit claims. 7 Taxpayers must be prepared to defend their supply expenditures through detailed record-keeping and a clear audit trail. 9

Substantiating Physical Location

The DOR may request proof that supplies were actually used in Massachusetts. 25 Taxpayers should maintain shipping records, receiving reports, and inventory logs that show the delivery and consumption of materials at a Massachusetts facility. 17 For companies with centralized procurement that ships materials to multiple states, a system of internal transfers must be documented to show which portion of the supply pool was consumed in the Commonwealth. 17

Demonstrating Non-Depreciable Status

Audit teams often scrutinize larger supply claims to ensure that the items are not actually capital assets. 4 Taxpayers should be ready to provide their capitalization policy and their fixed asset ledger to prove that the claimed supplies were expensed for book purposes and do not meet the criteria for depreciation under Section 167. 4 If a prototype cost is high, the auditor may ask for documentation regarding the eventual disposition of that prototype—if it was sold, destroyed, or remains on the floor as a functional tool. 17

Linking to Qualified Research Activities (QRAs)

Under the “Four-Part Test” adopted from IRC Section 41, research must be technological in nature, intended to eliminate technical uncertainty, involve a process of experimentation, and aim for a permitted purpose (e.g., a new or improved product). 10 Supplies can only be included in the credit if they are directly used in an activity that meets all four parts. 4 Auditors may request “nexus documents”—lab notes, white papers, or project summaries—that specifically tie the consumption of materials to the resolution of a technical uncertainty. 9

Conclusion: Strategic Implications for Massachusetts Businesses

The meaning of “supplies used or consumed” within the context of the Massachusetts R&D tax credit is a critical junction where federal definitions and state-specific geographic mandates converge. By adopting the IRC Section 41 definition, the Commonwealth ensures a degree of familiarity for multi-state corporations; however, the strict “in Massachusetts” requirement and the nuanced interpretation of what constitutes a non-depreciable asset place a high premium on precise accounting. 1

The evolution of state guidance—from the 2014 introduction of the Alternative Simplified Method to the 2024 expansion for biodefense and the 2025 opening for financial institutions—demonstrates a legislature and revenue office that are responsive to the changing nature of innovation. 1 For businesses, the R&D credit remains more than just a tax offset; it is a vital tool for managing cash flow and reinvesting in the talent and materials necessary to solve the next generation of technical challenges. 9

Ultimately, success in claiming and defending research supply expenses depends on the alignment of engineering data, procurement records, and tax strategy. 9 As Massachusetts continues to lead in sectors like life sciences, defense, and climatetech, the ability to accurately capture every dollar of “supplies used or consumed” will remain a significant competitive advantage for corporations operating within the Commonwealth. 20

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