Detailed Analysis of the Base Amount Metric within the Michigan Research and Development Tax Credit Framework

The Michigan research and development tax credit defines the base amount as the average annual qualifying research expenses incurred within the state during the three calendar years immediately preceding the credit year. This statutory benchmark serves to differentiate between baseline innovation maintenance and the higher-tier incremental investment that qualifies for enhanced credit rates of up to fifteen percent.

The reintroduction of the research and development (R&D) tax credit in Michigan, through the passage of Public Acts 186 and 187 of 2024, represents a significant shift in the state’s economic policy, specifically designed to foster innovation and retain high-tech talent within the Great Lakes State.1 Effective for tax years beginning on or after January 1, 2025, this credit provides a mechanism for both corporations and flow-through entities to recover a portion of their investment in qualified research activities.1 Central to the calculation of this credit is the “base amount,” a metric that ensures the state incentivizes not just existing R&D activities, but the expansion of those activities over time.4 Understanding the base amount requires an analysis of its statutory definition, the specific guidance issued by the Michigan Department of Treasury, and the broader context of federal tax conformity and decoupling.5

The Statutory Architecture of the Michigan R&D Credit

The legal foundations for the Michigan R&D credit are found in House Bills 5100 and 5101, which were signed into law on January 13, 2025, and codified as MCL 206.677 and MCL 206.717.2 These statutes establish a refundable credit for “authorized businesses” that incur “qualifying research and development expenses” in Michigan.3 Unlike the previous iteration of the Michigan R&D credit, which expired in 2012, the new credit is designed to be accessible through the standard income tax system rather than being administered like a discretionary grant program.3 This shift to an automatic, statutory credit ensures that all qualifying businesses, regardless of their political connections or administrative sophistication, can access the incentive.3

Defining Authorized Businesses and Qualifying Expenses

An authorized business eligible for the credit includes any taxpayer subject to the Michigan Corporate Income Tax (CIT) or any flow-through entity (FTE) that is an employer subject to Michigan income tax withholding.6 The definition of “qualifying research and development expenses” is strictly tied to Section 41(b) of the Internal Revenue Code (IRC), but with a critical geographic limitation: the research must be conducted entirely within the state of Michigan.1 Expenses incurred for research conducted outside of Michigan cannot be used to calculate the current-year credit or to establish the historical base amount.6

Qualified expenses typically fall into three primary categories as defined by the federal four-part test: wages paid to employees directly involved in research, supplies used in the experimentation process, and a percentage of contract research costs paid to third parties.4 The Michigan Department of Treasury has clarified that while the state uses the IRC Section 41 definition for what constitutes an “expense,” it does not necessarily follow all other federal regulations or concepts unless they are explicitly incorporated into the Michigan Income Tax Act.6 This independence allows Michigan to maintain a distinct calculation method for the base amount that differs from the federal Alternative Simplified Credit (ASC) or the regular credit methods.11

Deconstructing the Base Amount Calculation

The base amount is the mathematical threshold that determines the tiering of the credit rates.2 For a business to generate a credit at the higher incremental rates, its current-year Michigan R&D spending must exceed this historical average.1

The Three-Year Rolling Average

Statutorily, the base amount is defined as the average annual amount of qualifying research and development expenses incurred during the three calendar years immediately preceding the calendar year for which the credit is claimed.1 This rolling average is updated every year, meaning the base amount for a 2026 claim will use data from 2023, 2024, and 2025.9 This structure creates a moving target that encourages businesses to progressively increase their R&D investment to maintain the same level of tax benefit.4

The n-Year Divisor Rule

A critical nuance in the Michigan law, as clarified by the Department of Treasury, is how the average is calculated for businesses with less than three years of R&D history in the state.1 If a business only incurred qualifying expenses in one or two of the preceding three years, the average is based only on the number of years during which those expenses were actually incurred.9 If a business has no prior qualifying R&D expenses in Michigan, the base amount is zero.1

Tax professionals have highlighted that this method of calculation can be more restrictive than the federal ASC method.16 Under the federal ASC, the base amount is typically calculated as $50\%$ of the average of the three prior years’ QREs.11 Michigan’s requirement to use $100\%$ of the average, and to use a smaller divisor for newer programs, effectively raises the bar for what constitutes “excess” spending.16 For example, a company that spent $\$100,000$ in its only prior year of R&D (Year -1) would have a Michigan base amount of $\$100,000$, whereas if it had used a traditional three-year average with a fixed divisor of three, its base would have been only $\$33,333$.16

Data sourced from.1

Tiered Credit Rates and the Impact of Employee Count

The primary function of the base amount is to serve as the dividing line between the two tiers of the Michigan credit.3 The specific rates and caps applied to these tiers depend on the size of the authorized business, determined by the total number of employees.3

Small Business Credit Mechanics

Authorized businesses with fewer than 250 employees are categorized as small businesses.3 These entities receive a more robust incentive to encourage early-stage growth and innovation.10 The credit for a small business is calculated as $3\%$ of qualifying R&D expenses up to the base amount, and $15\%$ of qualifying R&D expenses that exceed the base amount.1 The total credit available to a small business is capped at $\$250,000$ per taxpayer per year.1

The $15\%$ rate for excess spending is a powerful tool for startups.10 Because a startup with no prior R&D history has a base amount of zero, every dollar of its current-year Michigan R&D spending qualifies for the $15\%$ rate until it hits the $\$250,000$ cap.10 This provides immediate, refundable liquidity for companies that are often pre-revenue or in a loss position.5

Large Business Credit Mechanics

Businesses with 250 or more employees are subject to a different rate structure and a higher overall cap.3 For these larger organizations, the credit is calculated as $3\%$ of qualifying R&D expenses up to the base amount, and $10\%$ of expenses exceeding the base amount.1 While the incremental rate is lower than that of small businesses ($10\%$ vs. $15\%$), the total annual cap is significantly higher, set at $\$2,000,000$ per taxpayer.3

This tiered system ensures that while large industrial firms can access substantial credits to support their existing research infrastructure, the state’s budget is prioritized toward rewarding aggressive growth in innovation spending.5 For a large business, the base amount serves as a high-water mark; they must maintain their historical spending to keep the $3\%$ credit and must exceed it to unlock the more lucrative $10\%$ tier.2

Data sourced from.1

Revenue Office Guidance and Interpretive Clarifications

The Michigan Department of Treasury has released several critical documents since the passage of Public Acts 186 and 187, most notably the “Notice Regarding New Research and Development Credit” and a follow-up response to stakeholder comments issued in April 2025.1 This guidance is essential for businesses attempting to operationalize the credit, as it addresses several administrative and technical questions not fully detailed in the original legislation.1

The Mandatory Calendar Year Basis

A standout feature of the Michigan R&D credit is that it must be calculated on a calendar-year basis for all claimants, regardless of the taxpayer’s actual fiscal year-end.6 This requirement applies to both the current-year QREs and the three-year base amount period.6 This is a departure from federal R&D credit rules, where calculations are typically aligned with the taxpayer’s fiscal year.16

For a fiscal-year filer, this mandate necessitates a “look-through” approach where R&D expenses must be bifurcated and aggregated into calendar-year buckets.16 The Department of Treasury has announced it will develop an “optional method” specifically for fiscal-year filers to convert their historical fiscal-year expenses into calendar-year equivalents for the base amount years prior to 2025.6 This conversion method is expected to simplify the look-back process for companies that may not have tracked their Michigan-specific R&D costs on a calendar basis in 2022, 2023, or 2024.5

Unitary Business Group (UBG) Consolidation

Guidance regarding Unitary Business Groups (UBGs) under the Corporate Income Tax is particularly important for large corporate taxpayers.7 The Treasury has confirmed that where a UBG exists, the group is considered the “taxpayer” for all purposes of the credit.6 Consequently, the calculation of the number of employees, total Michigan R&D expenses, the base amount, and the annual credit cap must all be performed at the aggregate UBG level.6 This means a UBG cannot claim multiple $\$2$ million credits for its individual members; rather, the entire group is limited to a single $\$2$ million annual cap.16

Flow-Through Entities and Withholding Tax

The Treasury’s guidance for flow-through entities (FTEs) highlights a unique mechanical implementation of the credit.2 FTEs that are employers subject to Michigan income tax withholding can claim the credit on their annual withholding return.2 Crucially, the credit is claimed by the entity itself and does not pass through to the individual members or owners.6 This allows the FTE to receive a direct refund, which can then be used for reinvestment in the business.2

Furthermore, the Treasury has provided relief for FTEs regarding periodic withholding payments.5 Once the Treasury issues its tentative claim adjustment notice for a given year, an FTE has the option to begin reducing its periodic withholding payments in anticipation of the credit refund, thereby improving immediate cash flow.5

The Tentative Claim Gateway and State Funding Caps

To manage the fiscal impact on the state budget, Michigan has implemented a two-step filing process.1 The base amount calculation must be submitted as part of a “tentative claim” before the credit can be formally reported on a tax return.6

Filing Deadlines and Requirements

For the 2025 tax year, all claimants (including both calendar-year and fiscal-year filers) must submit their tentative claims to the Michigan Department of Treasury no later than April 1, 2026.1 For R&D expenses incurred in calendar years after 2025, the statutory deadline moves up to March 15 of the following year.1

The tentative claim must identify the unadjusted credit amount and include the actual Michigan QREs and base amount calculations.6 Treasury has emphasized that these claims must be based on actual expenses, as they are used to determine if proration of the state’s $\$100$ million cap is required.1 Tentative claims submitted after the statutory deadline will not be accepted, making the business ineligible for the credit for that calendar year.6

Proration Mechanics and the Statewide Cap

The total aggregate amount of all R&D credits allowed in Michigan is capped at $\$100$ million per calendar year.2 This cap is further divided to protect small businesses: $\$25$ million is reserved exclusively for companies with fewer than 250 employees.1

If the total volume of tentative claims exceeds these limits, the Department of Treasury is required by law to prorate the credits.1 The proration sequence is as follows:

1. Small Business Pool: If total tentative claims from small businesses do not exceed $\$25$ million, these claims are paid in full without proration.2
2. Large Business Pool: Large business claims are paid from the remaining portion of the $\$100$ million pot after small business claims are satisfied.2 If the remaining funds are insufficient to cover all large business claims, those claims are prorated accordingly.2
3. Universal Proration Exception: If small business claims exceed $\$25$ million, or if they represent more than $25\%$ of the total aggregate claims submitted by all businesses, the Treasury may apply a universal proration where every claimant’s credit is reduced to ensure the $\$100$ million total is not exceeded.2

Treasury intends to publish a general notice on its website by April 30 each year, notifying taxpayers if proration is required and the specific percentage of the adjustment.1 This notice will not contain taxpayer-specific information to maintain confidentiality.1

Comprehensive Credit Calculation Example

To better understand the interaction between the base amount, the tiered rates, and the university bonus, consider the following detailed example of a Michigan electronics manufacturer.

Company Profile: Great Lakes Circuitry LLC

• Employee Count: 150 (Qualified as a Small Business) 3
• Partnership: Formally collaborates with Michigan State University 11
• Tax Year: Calendar Year 2025 3

Step 1: Historical Data and Base Amount Calculation

The company must first determine its Michigan-based QREs for the three preceding calendar years.7

• 2022 Michigan QREs: $\$200,000$
• 2023 Michigan QREs: $\$300,000$
• 2024 Michigan QREs: $\$400,000$

The base amount is the simple average of these three years:

$$\text{Base Amount} = \frac{\$200,000 + \$300,000 + \$400,000}{3} = \$300,000$$

9

Step 2: Determine Current Year Qualifying Expenses

For the 2025 calendar year, Great Lakes Circuitry LLC incurs the following Michigan QREs:

• Total Michigan QREs: $\$800,000$ 10
• University-Related QREs: $\$100,000$ (Included in the total) 11

Step 3: Compute the Unadjusted Credit Amount

As a small business, the credit is $3\%$ on the base amount and $15\%$ on the excess.3

• Credit on Base Amount: $0.03 \times \$300,000 = \$9,000$ 7
• Excess Expenses: $\$800,000 – \$300,000 = \$500,000$ 10
• Credit on Excess: $0.15 \times \$500,000 = \$75,000$ 3
• University Collaboration Bonus: $0.05 \times \$100,000 = \$5,000$ 10
• Total Unadjusted Credit: $\$9,000 + \$75,000 + \$5,000 = \$89,000$ 10

Step 4: Compliance with Caps and Proration

The unadjusted credit of $\$89,000$ is below the $\$250,000$ small business cap and the $\$200,000$ university cap.3 The company must submit this $\$89,000$ figure in its tentative claim by April 1, 2026.6 If the Treasury subsequently issues a notice that small business claims were not prorated, the company can claim the full $\$89,000$ as a refundable credit on its 2025 tax return.2

Interaction with Federal Tax Policy and IRC Section 174

A critical factor making the Michigan R&D credit particularly valuable is the state’s decision to decouple from recent federal changes regarding the treatment of research expenses.5

Federal Amortization Requirements

Under the federal Tax Cuts and Jobs Act (TCJA), effective for tax years beginning after December 31, 2021, businesses are no longer permitted to immediately expense R&D costs.5 Instead, they must capitalize and amortize domestic R&D costs over five years and international R&D costs over fifteen years.5 While the federal “One, Big, Beautiful Bill” (H.R. 1) attempted to restore immediate expensing for domestic costs at the federal level beginning in 2025, Michigan enacted House Bill 4961 in October 2025, which updated Michigan’s Internal Revenue Code conformity date but specifically decoupled from the immediate expensing provisions.1

The Importance of the Refundable Credit

Because Michigan continues to require the five-year amortization of domestic R&E expenditures, Michigan businesses face a higher immediate state tax burden than they would if immediate expensing were allowed.1 The new R&D tax credit serves as a vital offset to this amortization requirement.5 For many taxpayers, the credit will be essential to restore the cash-flow benefits lost due to capitalization.5 The refundable nature of the Michigan credit means that even if a company’s tax liability is low because they are amortizing expenses rather than deducting them fully, they can still receive a cash payment from the state to fuel further innovation.1

Strategic Implications and Compliance Requirements

The reintroduction of the Michigan R&D credit, and specifically the role of the base amount, necessitates a rigorous approach to documentation and tax planning.4

Substantiation and Documentation

To successfully claim the credit and survive an audit, businesses must maintain detailed records that justify both their current-year QREs and their three-year base amount history.4 The Michigan Department of Treasury requires documentation that reflects actual, not estimated, expenses.1 Key records include:

• Project Descriptions: Detailed objectives and the technical uncertainties being addressed.4
• Payroll Records: Specific time logs or allocation percentages for employees conducting, supervising, or supporting research.4
• Supply Invoices: Evidence that supplies were consumed specifically in the R&D process in Michigan.4
• Contractor Agreements: Written contracts for third-party research, along with evidence that the research was physically performed in Michigan.4
• University Agreements: For the collaboration bonus, a formal written agreement with a Michigan public university or independent non-profit research institute is mandatory.10

Audit and Record Retention

The Michigan Department of Treasury has the authority to audit R&D credit claims, and businesses are advised to retain all supporting documentation for at least four years.10 Given the geographic restriction of the credit, businesses with operations in multiple states must have a clear methodology for isolating their Michigan-specific costs.5

Conclusion

The base amount metric is the central pillar of the Michigan Research and Development tax credit, serving as the benchmark for a tiered system that aggressively rewards growth in innovation investment. By utilizing a three-year rolling average of state-specific qualifying expenses, Michigan has created a targeted incentive that prioritizes the expansion of high-tech industries within its borders. While the administrative requirements—including the mandatory calendar-year reporting, the tentative claim gateway, and the potential for proration—add complexity to the tax filing process, the refundable nature of the credit and its high incremental rates of up to fifteen percent offer a powerful financial tool for businesses of all sizes. As the state continues to decouple from federal expensing provisions, the Michigan R&D credit becomes an even more critical component of a company’s long-term tax strategy, providing essential liquidity and reinforcing Michigan’s position as a national leader in industrial and technological research.

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