Strategic Analysis of Michigan Public Acts 186 and 187: The Restoration of the Research and Development Tax Credit Framework

Public Acts 186 and 187 of 2024 establish a refundable state tax credit for qualified research and development expenses incurred in Michigan beginning in 2025. This legislation aims to catalyze innovation by providing tiered financial offsets based on business size, incremental growth, and university partnerships. 1

The enactment of this legislative package represents a significant pivot in Michigan’s long-term economic strategy, marking the return of sector-specific innovation incentives that had been largely absent since the major tax overhauls of 2012. 2 By re-establishing a state-level Research and Development (R&D) credit, Michigan joins the majority of U.S. states in providing a mechanism to lower the effective cost of technological advancement. 3 The timing of this legislation is particularly consequential for Michigan’s business community due to recent shifts in federal tax law under the “One Big Beautiful Bill Act,” which reinstated immediate expensing of domestic research costs at the federal level—a provision from which the State of Michigan has explicitly decoupled. 5 Consequently, the new Michigan R&D credit serves not only as a growth incentive but also as a vital liquidity tool to offset the mandatory state-level amortization of research expenditures. 6

The Historical and Economic Context of Michigan’s Innovation Policy

The trajectory of Michigan’s business taxation has been defined by a tension between the desire for a simplified, low-rate tax code and the need for targeted incentives to remain competitive in high-tech industries. 2 Historically, Michigan utilized the Single Business Tax (SBT) from 1976 through 2007, which incorporated R&D credits as a core component of the state’s industrial policy. 2 The SBT was eventually replaced by the Michigan Business Tax (MBT) in 2008, a system that maintained these incentives but faced criticism for its complexity and the administrative burden it placed on taxpayers. 2

The transition to the Corporate Income Tax (CIT) on January 1, 2012, was intended to streamline the tax environment by moving toward a standard 6% rate and eliminating a broad swath of credits. 2 While this reform simplified the tax landscape, it effectively left Michigan as the only state in the Midwest without a research and development incentive, a factor that economic development organizations cited as a barrier to attracting global investment and retaining highly skilled technical talent. 4 Public Acts 186 and 187 of 2024 are designed to bridge this competitive gap, aligning Michigan’s fiscal policy with the modern requirements of the automotive, semiconductor, and life sciences sectors. 2

Comparison of Michigan Business Tax Structures

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Legal Architecture of Public Acts 186 and 187

The 2024 R&D legislation is bifurcated to ensure equitable treatment across different business structures. 6 Public Act 186 targets corporations subject to the Corporate Income Tax, while Public Act 187 addresses flow-through entities such as S-corporations and partnerships. 12

Public Act 186: Corporate Income Tax Compliance

Public Act 186 amends the Income Tax Act of 1967 by inserting Section 677. 13 This section empowers “authorized businesses” to claim a credit for qualifying research and development expenses (QREs) incurred within the calendar year. 13 Eligibility is predicated on the business increasing its QREs relative to a predetermined base amount. 1 A critical administrative feature of PA 186 is its requirement for the submission of a “tentative claim” to the Michigan Department of Treasury, a step that precedes the final reporting on the annual corporate income tax return. 1

Public Act 187: Flow-Through Entity and Withholding Credits

Public Act 187 adds Section 717 to the Income Tax Act, focusing on flow-through entities (FTEs) and small employers. 14 Unlike traditional pass-through credits where the tax benefit flows to the individual owners’ personal returns, the Michigan R&D credit for FTEs is claimed at the entity level against its withholding tax liability. 16 To qualify under PA 187, an FTE must be subject to Michigan income tax withholding on its employees and must not be a disregarded entity for tax purposes. 16 This structural choice ensures that the liquidity benefit of the credit remains within the entity conducting the research, facilitating immediate reinvestment into R&D activities. 18

Technical Framework for Qualified Research Expenses

The Michigan R&D credit relies heavily on the definitions established at the federal level but imposes strict geographic limitations. 1 The legislation adopts the definition of “qualified research expenses” as set forth in Section 41(b) of the Internal Revenue Code (IRC). 13

The Michigan-Situs Requirement

While the state utilizes federal definitions for the types of eligible expenses, it applies a rigorous “Michigan-only” rule for the location of the research. 13 Only research conducted within the physical boundaries of the state of Michigan qualifies for the credit. 13 This means that a Michigan-headquartered company conducting research at a facility in another state or country must exclude those expenditures from both their current-year credit calculation and their base-amount average. 16

Categories of Eligible Expenditures

Taxpayers may include three primary categories of costs in their QRE calculations, provided the activities meet the federal “Four-Part Test” of being technological in nature, intended to eliminate uncertainty, and part of a process of experimentation. 4

1. Direct Wages: Salaries and compensation for employees directly performing research, as well as those providing direct supervision or support for research activities. 4
2. Supplies: The cost of materials and supplies consumed in the research process, including raw materials for prototypes and testing equipment. 4
3. Contract Research: A percentage of the amounts paid to third-party consultants or research organizations (typically 65% under federal rules) for research performed on the taxpayer’s behalf within the state. 4
4. Cloud Server Expenses: Payments for the rental of off-site or cloud-based server space specifically utilized for the design or testing of new or improved software. 6

Calculating the Incentive: Tiered Rates and Base Amounts

The Michigan credit is designed as an incremental incentive, rewarding businesses that expand their investment in research. 20 The calculation requires a comparison between the current calendar year’s QREs and the taxpayer’s “base amount.” 12

Determining the Base Amount

The base amount is defined as the average annual amount of qualifying Michigan R&D expenses incurred during the three calendar years immediately preceding the calendar year for which the credit is claimed. 12 The Michigan Department of Treasury has issued specific guidance on various scenarios:

• New Businesses: For companies with no prior R&D history, the base amount is zero. 1
• Established Businesses with Intermittent Research: If a business incurred R&D expenses in only one or two of the preceding three years, the average is calculated using only the years in which expenses were present. 1
• Short Taxable Years: Treasury guidance clarifies that short taxable years are treated as full years for the purposes of the base amount calculation, and no annualization of expenses is required or permitted. 1

The Tiered Rate Structure

The legislation provides distinct rates based on the size of the business, as measured by employee count. 1 A “small business” is defined as having fewer than 250 employees, while a “large business” has 250 or more employees. 3

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The logic behind this tiered structure is to provide a more robust percentage of relief to smaller firms and startups, which are often more sensitive to the immediate costs of innovation, while providing a higher total dollar ceiling for large corporations engaged in capital-intensive research projects. 10

University Collaboration Bonus

In addition to the standard credit, businesses can earn a 5% “bonus” credit for research conducted in collaboration with a Michigan public research university. 1 This collaborative credit is capped at $200,000 per taxpayer annually and requires a formal, written agreement with the university. 3 This provision is intended to strengthen the nexus between Michigan’s academic institutions and the private sector, fostering a more integrated ecosystem for commercializing new technologies. 2

The Fiscal Management Model: Aggregate Caps and Proration

To protect the state’s General Fund from unpredictable revenue volatility, the total amount of R&D credits allowed across all taxpayers is capped at $100 million per calendar year. 1 If the aggregate of all tentative claims submitted to the Department of Treasury exceeds this limit, a mandatory proration system is triggered. 1

The Small Business Priority and Proration Mechanics

The legislation includes a protective mechanism for small businesses, reserving $25 million of the $100 million total for firms with fewer than 250 employees. 1 The proration rules are structured as follows:

1. Small Business Stability: If total claims from small businesses are less than or equal to $25 million, those claims are paid in full. Large business claims are then prorated against the remaining $75 million (plus any leftover small business funds). 3
2. Category-Specific Proration: If small business claims exceed $25 million but represent less than 25% of all claims, small business credits are prorated to fit the $25 million cap, and large business credits are prorated to fit the $75 million cap. 12
3. Global Proration: If small business claims exceed 25% of the total statewide claims, the individual category caps are set aside, and all claims (large and small) are prorated equally against the $100 million total fund. 3

Treasury guidance indicates that the department will publish a proration notice on its website by April 30 each year, providing transparency to taxpayers regarding the final adjusted value of their credits. 1

Administrative Guidance and the Compliance Lifecycle

Compliance with the Michigan R&D credit involves a two-step process that differs from the standard self-reporting of most tax credits. 1

The Tentative Claim Mandate

The most critical procedural requirement is the filing of a “tentative claim.” 1 Taxpayers must submit actual, not estimated, R&D expense data to the Department of Treasury according to a strict timeline. 1

• Tax Year 2025: For expenses incurred in the 2025 calendar year, the tentative claim deadline is April 1, 2026. 1
• Subsequent Years: For 2026 and beyond, the deadline moves to March 15 of the following year. 2

Failure to submit a timely tentative claim results in the forfeiture of the credit for that tax year. 18 Treasury has explicitly stated that no extensions will be granted for the tentative claim filing, as the data is required to calculate the statewide proration. 18

Final Reporting and Refundability

Once Treasury has analyzed the tentative claims and published any necessary proration adjustments, the taxpayer then reports the finalized credit on their annual tax return. 1 The credit is claimed after all other nonrefundable credits have been applied. 1 Because the credit is fully refundable, if it exceeds the business’s total tax liability, the excess is paid out as a cash refund. 1

For flow-through entities, Treasury has provided an additional administrative flexibility: once the proration notice is published in late April, the FTE may immediately reduce its periodic withholding payments to account for the anticipated R&D credit, providing a near-term cash flow benefit even before the annual SUW return is filed. 18

State-Federal Conformity and the Amortization Challenge

A vital component of the Michigan R&D credit’s “meaning” is its role in mitigating the impact of federal tax law changes. 6

Decoupling from IRC Section 174A

Under the federal “One Big Beautiful Bill Act,” the United States reinstated the immediate expensing of domestic R&D costs (IRC Section 174A). 1 However, Michigan chose to decouple from this provision. 1 Consequently, for Michigan tax purposes, businesses are required to capitalize their research expenses and amortize them over five years for domestic activities and 15 years for foreign activities. 1

This decoupling creates a substantial timing difference in tax liability. 6 While a business may deduct 100% of its research costs on its federal return, it may only deduct a fraction on its Michigan return in the same year. This increases Michigan taxable income and, by extension, the state tax burden. 6 The new R&D credit is explicitly designed to offset this specific liquidity drain, providing a direct reduction of state liability for the same expenditures that must be amortized. 6

Comparison of Federal vs. Michigan Treatment of R&D Costs

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Revenue Office Guidance on Complex Business Structures

The Michigan Department of Treasury has released several clarifying notices to address how the R&D credit applies to sophisticated corporate environments. 16

Unitary Business Groups (UBGs)

For taxpayers filing as a Unitary Business Group, the UBG itself is considered the taxpayer. 16 Treasury guidance specifies that all calculations—including the base amount, the current year QREs, and the employee count used to determine the credit rate—must be performed at the consolidated group level. 16 The designated member of the UBG files the single tentative claim and the final credit claim on the UBG’s annual return. 1

Disregarded Entities and FTE Members

The legislation strictly limits the credit to the entity that actually incurs the expenses. 1 Disregarded entities are not eligible to claim the credit independently. 1 Furthermore, for flow-through entities, the credit is claimed at the entity level against withholding; individual members or owners of the FTE are explicitly prohibited from claiming a portion of the credit on their personal income tax returns. 16 This is a significant departure from many other state tax credits, which traditionally pass through to shareholders or partners. 18

Detailed Implementation Example: Small Tech Startup

To provide a concrete example of how the law and Treasury guidance apply, consider “InnovateMI LLC,” a software development firm with 45 employees. 1

Case Background

In 2025, InnovateMI spends $500,000 on Michigan-based research to develop a new AI-driven diagnostic tool. 13 They also have a collaborative agreement with Michigan State University for an additional $100,000 in research. 13 Their Michigan QRE history for the previous three years is:

• 2022: $200,000
• 2023: $300,000
• 2024: $400,000

Step 1: Base Amount Calculation

The base amount is the average of the prior three years of Michigan QREs.

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

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Step 2: Tentative Credit Calculation

InnovateMI qualifies as a small business (under 250 employees), entitling them to 3% on the base and 15% on the excess. 1

1. Credit on Base: $300,000 \times 3\% = \$9,000$
2. Credit on Excess: $(500,000 – 300,000) \times 15\% = \$30,000$
3. University Collaboration Bonus: $100,000 \times 5\% = \$5,000$
4. Total Tentative Claim: $9,000 + 30,000 + 5,000 = \$44,000$
   
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Step 3: Submission and Proration

InnovateMI submits their tentative claim of $44,000 to the Department of Treasury by April 1, 2026. 3 If Treasury subsequently determines that the statewide $100 million cap has been reached and applies a proration of 90%, the final credit allowed to InnovateMI would be $39,600. 12

Step 4: Final Reporting

InnovateMI, as an FTE, reports the $39,600 on their annual SUW return due February 28, 2027. 6 If they have already reduced their 2026 monthly withholding payments following the April 2026 notice, they have already effectively received the cash-flow benefit of this credit. 18

Audit and Substantiation: Maintaining Eligibility

The Michigan Department of Treasury retains the authority to audit R&D credit claims. 10 Taxpayers are advised to maintain records for at least four years, including:

• Time Logs and Payroll Records: Documentation linking specific employee hours to qualified research activities performed within Michigan. 6
• Project Documentation: Descriptions of the research goals, technical uncertainties, and the process of experimentation evaluated. 10
• Supply Invoices: Records of materials consumed during the research phase, ensuring they were not part of commercial production. 6
• Written Agreements: Fully executed contracts for any university collaboration or third-party contract research. 2

The Department’s guidance emphasizes that simply claiming the credit on a federal return does not automatically guarantee state eligibility; the Michigan-specific nexus and the tiered rate rules require independent substantiation. 16

Conclusion: Strategic Implications for the Michigan Business Community

The enactment of Public Acts 186 and 187 of 2024 represents a fundamental restoration of Michigan’s competitive posture in the global innovation economy. 2 By providing a refundable tax credit that specifically rewards incremental growth in research expenditures, Michigan has addressed a critical gap in its business tax framework. 5 The $100 million annual commitment, while capped, provides significant liquidity to the sectors that form the backbone of the state’s high-tech future. 1

For businesses, the “meaning” of this legislation is two-fold: it is an opportunity for significant tax savings and a mandatory administrative hurdle that requires meticulous tracking of in-state costs. 3 The decoupling from federal Section 174 amortization makes the credit essentially mandatory for firms looking to maintain their current cash-flow levels. 6 As Michigan transitions into this new era of innovation incentives, businesses must align their internal accounting systems with the Department of Treasury’s tentative claim process and base-amount rules. 6 Through these strategic investments, Michigan aims to transition from a legacy manufacturing hub into a leader of the next generation of technological development. 2

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