Detailed analysis of qualified research expenses and the Michigan research and development tax credit framework

Qualified research expenses in Michigan constitute the specific costs of labor, supplies, and contracted services directly associated with technological innovation and product development conducted physically within the state’s borders. These expenses serve as the foundational metric for calculating a newly established refundable tax credit designed to incentivize high-tech investment and bolster Michigan’s position as a global leader in innovation.

The reintroduction of the Michigan Research and Development (R&D) tax credit through Public Acts 186 and 187 of 2024 represents a watershed moment for the state’s economic policy. Following more than a decade of legislative absence, this incentive package provides a critical mechanism for businesses to offset the high costs associated with domestic innovation.1 By anchoring the state-level definition of Qualified Research Expenses (QREs) to the federal standard established under Internal Revenue Code (IRC) Section 41(b), Michigan has created a framework that is both familiar to tax professionals and strictly tailored to benefit the local economy through its “conducted in Michigan” requirement.3 This report provides an exhaustive examination of the legal definitions, administrative guidance from the Michigan Department of Treasury, and the strategic implications of the credit for various business classifications.

Legislative evolution and the restoration of innovation incentives

To understand the current application of QREs in Michigan, one must examine the state’s historical approach to research incentives. For much of the early 21st century, Michigan utilized the Single Business Tax (SBT) and subsequently the Michigan Business Tax (MBT) to provide targeted relief for research-heavy industries.1 However, the transition to the Corporate Income Tax (CIT) in 2012 resulted in the elimination of most business credits in favor of a lower, simplified flat tax rate.1 This policy shift, while intended to streamline the tax code, left Michigan at a competitive disadvantage compared to neighboring states that continued to offer aggressive R&D incentives.5

The enactment of House Bills 5100 and 5101 in early 2025, signed by Governor Gretchen Whitmer, officially re-established the R&D tax credit for tax years beginning on or after January 1, 2025.1 This bipartisan initiative was not merely a restoration of old policies but a modern restructuring aimed at fostering a “Make It in Michigan” strategy.7 The new credit is uniquely designed to be refundable, ensuring that even early-stage startups and pre-revenue technology firms can realize the immediate cash-flow benefits of their R&D investments.1

Statutory framework of the 2024 legislation

The legislative package is composed of several critical pillars that define the eligibility and calculation of the credit:

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These statutes collectively empower the Michigan Department of Treasury to administer a $100 million annual credit pool, with specific set-asides for small businesses to ensure equitable access to state resources.1

Technical definition of Michigan qualified research expenses

At the core of the state’s R&D credit is the definition of Qualifying Research Expenses. Michigan law explicitly adopts the federal definition found in IRC § 41(b), but it imposes a strict geographic limitation: the expenses must be for research “conducted in Michigan”.4 This means that while a taxpayer may have significant R&D costs globally or nationally, only the portion of activities physically occurring within the borders of the state can be used to determine the Michigan credit.2

The federal baseline under IRC Section 41(b)

Because the Michigan credit relies on the federal definition, an expense must first qualify under the four-part test established by the Internal Revenue Service (IRS). For an activity to be considered qualified research, it must meet the following criteria:

• Permitted Purpose: The research must be undertaken to develop a new or improved business component, such as a product, process, computer software, technique, formula, or invention.12
• Elimination of Uncertainty: The activity must be intended to discover information that would eliminate uncertainty concerning the development or improvement of the business component.16 This includes uncertainty regarding the capability of development, the method of development, or the appropriate design.16
• Process of Experimentation: Substantially all of the activities must involve a process of experimentation, which includes evaluating one or more alternatives, systematic trial and error, modeling, or simulation.12
• Technological in Nature: The research must fundamentally rely on the principles of physical or biological sciences, engineering, or computer science.16

Categories of eligible expenditures

Qualified research expenses generally fall into three main categories. Under Michigan’s guidance, each category must demonstrate a clear nexus to the state:

1. Wages: This include compensation paid to employees for performing “qualified services,” which are defined as engaging in qualified research, direct supervision of qualified research, or direct support of qualified research.12 Direct support includes activities such as a lab assistant cleaning testing equipment, while direct supervision refers to the first-line management of researchers.16
2. Supplies: Tangible property, other than land or improvements to land, used in the conduct of qualified research.12 This typically encompasses raw materials used in prototyping and testing.18
3. Contract Research Expenses: A portion of payments (typically 65% at the federal level, though Michigan focuses on the in-state performance) made to third parties for research conducted on behalf of the taxpayer.18 For Michigan, the third party must perform the work within the state.15
4. Cloud and Server Costs: Michigan specifically clarifies that expenditures for the rental of off-site and cloud-based server space used for the design or testing of new or improved software are qualifying expenses.17

The “Conducted in Michigan” requirement

The most critical distinction for Michigan taxpayers is the geographic restriction. Expenses incurred for research conducted outside of Michigan cannot be used to calculate the credit or to determine eligibility.4 This creates a high burden of substantiation for taxpayers with remote workforces or multi-state operations.3 Legal analysis suggests that even if a project is national in scope, Michigan will likely allow for a pro rata share of expenses based on the specific activities performed in-state, though documentation such as time logs and project descriptions must clearly delineate the Michigan-based effort.3

Classification of taxpayers: Small vs. Large businesses

The Michigan R&D credit structure is tiered, providing different rates and caps based on the size of the taxpayer’s workforce. This distinction is intended to provide more aggressive support to smaller innovators while still offering substantial relief to major industrial players.1

Small businesses (Fewer than 250 employees)

For businesses with fewer than 250 total employees, the state offers a more generous incremental rate. These entities are eligible for:

• 3% Credit: Applied to qualifying research expenses incurred during the calendar year up to the taxpayer’s base amount.1
• 15% Credit: Applied to qualifying research expenses that exceed the taxpayer’s base amount.1
• Annual Cap: The total credit for a small business is limited to $250,000 per tax year.1

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Large businesses (250 or more employees)

Larger enterprises, often in the automotive, semiconductor, or manufacturing sectors, follow a different calculation:

• 3% Credit: Applied to qualifying research expenses up to the base amount.1
• 10% Credit: Applied to qualifying research expenses that exceed the base amount.1
• Annual Cap: Large businesses are limited to a maximum credit of $2,000,000 per tax year.1

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Employee counting and Unitary Business Groups (UBGs)

The Department of Treasury has indicated it will develop specific guidance for counting the number of employees.4 Generally, the state follows the definition in IRC § 3401(c).22 For Unitary Business Groups (UBGs) filing under the Corporate Income Tax, the entire group is considered a single taxpayer.14 Consequently, the calculation for the 250-employee threshold, the base amount, and the maximum credit cap must be made at the aggregate group level.2

Calculating the base amount for the Michigan credit

The Michigan R&D tax credit is an incremental credit, meaning it aims to reward businesses that increase their innovation spending relative to their historical average. This historical average is known as the “base amount”.10

The rolling three-year average

The base amount is defined as the average annual qualifying research and development expenses incurred during the three calendar years immediately preceding the calendar year ending with or within the tax year for which the credit is claimed.9 For the first year of the credit (2025), the base amount will be the average of expenses incurred in 2022, 2023, and 2024.14

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Calendar-year vs. Fiscal-year filers

A significant administrative challenge of the Michigan credit is its strict adherence to a calendar-year basis for all calculations, regardless of the taxpayer’s fiscal year.4 This means that a business with a June 30 fiscal year-end must still compute its qualifying expenses and its base amount using data from January 1 through December 31.4 The Department of Treasury has acknowledged this complexity and intends to provide an optional method for fiscal-year filers to convert their fiscal-year data into calendar-year equivalent for base years prior to 2025.14

Short taxable years

For entities experiencing a short taxable year due to mergers, acquisitions, or changes in accounting periods, the Treasury has clarified that these periods will be treated as full years for calculation purposes.2 No annualization of expenses is required, which may impact the base amount average in subsequent years.2

The University Collaboration Bonus

To stimulate partnerships between private industry and the state’s academic institutions, Michigan offers an additional 5% credit bonus.1 This bonus is designed to encourage companies to utilize the world-class laboratories and faculty expertise at institutions like the University of Michigan and Michigan State University.8

Eligibility and requirements for the 5% bonus

The additional credit is available for qualifying research expenses incurred in collaboration with a “research university” in Michigan.1 A research university is defined as any public university or independent nonprofit college or university located within the state.4

To successfully claim this bonus, a taxpayer must:

• Perform the research pursuant to a formal written agreement with the university.1
• Provide a copy of the written agreement to the Department of Treasury upon request.4
• Ensure that the collaborative expenses are also included in the general QRE calculation.1

Caps on the collaboration credit

The additional collaboration credit is capped at $200,000 per tax year per taxpayer.1 It is important to note that this bonus is still subject to the overall per-taxpayer caps ($250,000 for small businesses and $2,000,000 for large businesses).8 Therefore, the collaboration credit essentially allows a taxpayer to reach their maximum annual cap more quickly or with a higher percentage of their total spend.27

State revenue office guidance and administrative processes

The Michigan Department of Treasury is the primary administrative body for the R&D credit. In April 2025, the Department issued a formal “Notice Regarding New Research and Development Credit,” which provides the most comprehensive look at how the law will be applied in practice.14

The tentative claim requirement

Unlike the federal R&D credit, which is simply reported on the annual income tax return, Michigan requires a preliminary filing known as a “tentative claim”.4 This process is essential for the Treasury to manage the $100 million statewide cap.1

The tentative claim must identify:

• Whether the taxpayer is claiming as a small or large business.9
• The total amount of qualifying research expenses incurred.9
• Whether the taxpayer is claiming the additional university collaboration credit.9

Deadlines for Tentative Claims:

• For 2025 calendar year: Due by April 1, 2026.4
• For 2026 and beyond: Due by March 15 of the following year.1

Submission of a timely tentative claim is a prerequisite for eligibility; late claims will not be approved.4

The proration notice and adjusted credit

Because the total aggregate amount of credits available to all taxpayers is capped at $100 million per calendar year, the Treasury must review all tentative claims before final awards are granted.1 If total claims exceed the cap, the Treasury will publish a notice on its website (anticipated by April 30 each year) detailing the proration adjustments.4

The proration rules are designed to protect small businesses:

• Small Business Set-Aside: $25 million is reserved for businesses with fewer than 250 employees.8
• Small Business Protection: If total small business claims are under $25 million, they are not prorated, while large business claims are prorated against the remaining $75 million.1
• Universal Proration: If small business claims exceed 25% of all claims and the $100 million total is exceeded, all claimants are prorated across the full $100 million.8

Final reporting on annual returns

Once the proration notice is issued, taxpayers report their final, adjusted credit on their annual return.4

• CIT Taxpayers: Claim the credit on the annual CIT return for the year for which the credit is claimed.4
• Flow-Through Entities: Claim the credit on the annual withholding return for the tax year in which the tentative claim was filed.4
• Withholding Reductions: Flow-through entities that file a withholding tax return have the option to reduce their periodic withholding payments once the Treasury issues the tentative claim adjustment notice.4

Decoupling from IRC Section 174 amortization

A critical nuance for Michigan taxpayers is the state’s treatment of R&D expense capitalization. Historically, IRC Section 174 allowed for the immediate expensing of research and experimental (R&E) costs. However, recent federal changes required these costs to be capitalized and amortized over five years (for domestic research) or 15 years (for foreign research).2

Michigan’s mandatory capitalization

While the federal “One Big Beautiful Bill Act” (PL 119-21) eventually restored immediate expensing for domestic R&D at the federal level starting in 2025, Michigan enacted HB 4961 in October 2025, which updated the state’s IRC conformity date but specifically decoupled from federal Section 174(A).2

Consequently, for Michigan tax purposes:

• Domestic R&D costs must still be capitalized and amortized over a five-year period.2
• This creates a timing difference between state and federal taxable income, often resulting in a higher state tax liability in the early years of a project.17

The credit as a liquidity tool

The refundable nature of the Michigan R&D credit is intentionally designed to mitigate the negative cash-flow impact of this mandatory amortization.17 For many taxpayers, the credit will be essential to restore the benefits lost due to the amortization requirements.17 Proactive tax planning is necessary to ensure that the credit is maximized to offset the higher taxable income generated by the decoupling.2

Statistical overview and economic impact projections

The restoration of the R&D credit is supported by data suggesting significant economic multipliers for state-level innovation incentives.

National and state statistics

Research from the National Bureau of Economic Research (NBER) and the Michigan Economic Development Corporation (MEDC) provides the following insights:

• Investment Multiplier: Every $1 of R&D tax credit typically leads to approximately $4 in additional R&D spending by businesses over the long term.8
• Business Formation: States that have introduced R&D tax credits have seen a 20% growth in new firm formation over a ten-year period.5
• Michigan R&D Spending: Michigan businesses historically spend $22.4 billion annually on R&D, ranking the state in the top five nationally for R&D investment.8
• Industry Growth: The state’s engineering design and development sector is forecasted to attract over $143 million in private investments and generate more than 700 new jobs in 2025 alone due to these incentives.8

Budgetary and fiscal impacts

The state has balanced the need for innovation with fiscal responsibility by capping the program:

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Detailed example: Semiconductor startup in Ann Arbor

To illustrate the practical application of these rules, consider the case of “Micro-Logic LLC,” a semiconductor design firm based in Ann Arbor with 180 employees.

Step 1: Data collection and base amount calculation

Micro-Logic is classified as a Small Business because it has fewer than 250 employees.1 It has a written agreement for prototype testing with the University of Michigan.4

First, the firm must calculate its Michigan-specific base amount using its history of research conducted in Michigan:

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Step 2: Current year expenditure (2025)

In calendar year 2025, Micro-Logic incurs $2,500,000 in Michigan QREs. Of this amount, $400,000 is attributed to the collaboration with the University of Michigan.27

Step 3: Calculation of unadjusted credit

The unadjusted credit is the sum of the tiered rates and the university bonus:

1. Credit on Base Amount: 3% of the first $1,500,000 = $45,000.
2. Credit on Excess Amount: 15% of the excess ($2,500,000 – $1,500,000 = $1,000,000) = $150,000.
3. University Collaboration Bonus: 5% of the $400,000 collaborative spend = $20,000.

Total Unadjusted Credit: $45,000 + $150,000 + $20,000 = $215,000.

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Step 4: Submission and proration

Micro-Logic submits its tentative claim to the Department of Treasury by April 1, 2026.4 Because the $215,000 claim is below the small business cap of $250,000, it is eligible for the full amount, subject to statewide proration.1

If total small business claims for 2025 reach $30 million, the Treasury must prorate the $25 million reserve. Micro-Logic’s final adjusted credit would be its pro rata share:

$$\text{Adjusted Credit} = \$215,000 \times \left( \frac{\$25,000,000}{\$30,000,000} \right) = \$179,167$$

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The firm reports this $179,167 on its 2026 withholding return and receives a refund for any amount exceeding its liability.4

Strategic considerations for Michigan businesses

The re-establishment of the R&D credit requires businesses to adopt a more rigorous approach to documentation and tax planning than in previous years.

Documentation and substantiation

To survive a potential audit and satisfy the Treasury’s requirements, businesses must maintain detailed records.18 This includes:

• Project descriptions and objectives illustrating the technical uncertainty involved.17
• A precise breakdown of R&D expenses, including payroll records for staff involved in research.18
• Time logs or allocation studies to prove that employees were physically present in Michigan when the work was performed.3
• Executed copies of written agreements with research universities.1

Coordination with federal claims

While the Michigan credit is separate from the federal credit, the underlying data is largely the same.3 Taxpayers claiming the federal R&D credit under IRC Section 41 should leverage their federal computation to identify qualifying activities, but they must perform a separate analysis to carve out expenses not conducted within Michigan.10

Interaction with other state credits

It is important to note that the R&D credit cannot be claimed by taxpayers who are still filing under the Michigan Business Tax (MBT) due to a certificated credit election.24 Additionally, businesses must evaluate how the R&D credit interacts with other incentives, such as the Michigan Innovation Fund or regional job creation credits.1

Conclusion: Michigan’s return to the innovation stage

The Michigan Research and Development tax credit represents a sophisticated policy tool aimed at recapturing the state’s legacy as an industrial and technological powerhouse. By providing a clear, refundable path for recovering Qualified Research Expenses, the state has addressed long-standing concerns regarding the financial burden of domestic innovation.1

The meaning of QREs in Michigan is defined by a rigorous adherence to federal standards, tempered by a firm requirement for local economic activity. The tiered structure effectively balances the needs of small startups with those of large industrial giants, while the university collaboration bonus ensures that Michigan’s academic resources are fully integrated into the commercial ecosystem.1

As businesses navigate the 2025 tax year, the priority must be on precise data collection, timely filing of tentative claims, and a deep understanding of Michigan’s unique decoupling from federal Section 174 amortization. While the $100 million cap introduces a degree of uncertainty regarding final award amounts, the presence of a refundable credit significantly lowers the risk profile for R&D investments within the state.1 Ultimately, the successful implementation of this credit will be measured not just in tax dollars refunded, but in the growth of Michigan’s high-tech workforce and the state’s continued leadership in the global innovation economy.1

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