Comprehensive Analysis of Supplies Used or Consumed in the Michigan Research and Development Tax Credit Framework

In the state of Michigan, supplies used or consumed within the context of the Research and Development (R&D) tax credit refer specifically to tangible personal property, other than land or depreciable assets, that is physically expended or transformed during qualified research activities performed within the state’s boundaries.1 This includes raw materials, chemicals, and prototype components that are integral to the process of experimentation and are intended to eliminate technical uncertainty regarding the capability, design, or methodology of a new or improved business component.3

The reintroduction of a state-level R&D tax credit in Michigan, effective for tax years beginning on or after January 1, 2025, represents a significant legislative pivot aimed at restoring the state’s status as a hub for industrial and technological innovation.3 This credit, established by Public Acts 186 and 187 of 2024, is designed to provide substantial financial relief to businesses that increase their qualifying research expenses within the state.5 While the state’s framework draws heavily from federal definitions under Section 41(b) of the Internal Revenue Code (IRC), the Michigan Department of Treasury has introduced specific administrative requirements, geographic limitations, and a unique tentative claim process that distinguishes the state credit from its federal counterpart.8 Central to the determination of a taxpayer’s eligibility is the precise categorization of expenditures, particularly the distinction between supplies that are consumed in the research process and capital equipment that must be depreciated.10 As Michigan decouples from certain federal amortization requirements under IRC Section 174, the strategic importance of accurately identifying and documenting “supplies used or consumed” has escalated for both corporate entities and flow-through businesses seeking to maximize their refundable tax benefits.3

The Statutory Foundation: Michigan Public Acts 186 and 187 of 2024

The legislative journey to reestablish Michigan’s R&D tax credit concluded on January 13, 2025, when Governor Gretchen Whitmer signed House Bills 5100 and 5101 into law.5 These bills, which became Public Acts 186 and 187 respectively, target two distinct segments of the Michigan business community: corporate income tax (CIT) payers and flow-through entities (FTEs) such as S-corporations and partnerships.5 The dual-bill approach ensures that innovation is incentivized regardless of the business structure, provided the research activity is physically conducted within the state.5

The primary objective of this legislation is to lower the cost of innovation and foster the creation of high-paying jobs in sectors such as life sciences, advanced manufacturing, and vehicle technology.4 To achieve this, the law provides for a tiered credit system that favors small businesses—defined as those with fewer than 250 employees—while still offering significant benefits to large-scale industrial operations.3 The total amount of credit available statewide is capped at $100 million annually, with a dedicated $25 million set-aside specifically for small business claimants.3

The state’s decision to align with federal IRC Section 41 definitions for “qualified research expenses” (QREs) creates a familiar landscape for tax professionals but necessitates a nuanced understanding of how Michigan’s administrative procedures modify the application of these federal concepts.1 In particular, the requirement that all research be conducted in Michigan means that supply costs must be strictly segregated between in-state and out-of-state activities.2 This geographic nexus is not merely a formality; it is the cornerstone of the state’s efforts to ensure that tax expenditures directly stimulate the local economy.4

Defining “Supplies” Through the Federal Nexus: IRC Section 41(b)

Michigan’s R&D credit law explicitly adopts the definition of “qualified research expenses” provided in IRC Section 41(b).8 Under the federal framework, QREs are categorized into three distinct buckets: wages for qualified services, contract research expenses (generally limited to 65% of the amount paid), and amounts paid or incurred for supplies used in the conduct of qualified research.1 Understanding the technical definition of “supplies” is critical because it represents the most flexible category of R&D spending for many manufacturers and technology firms.3

Federal law defines “supplies” as any tangible personal property other than land or improvements to land and property of a character subject to the allowance for depreciation.11 This definition effectively excludes capital assets that have a useful life of more than one year and are subject to depreciation under IRC Section 167.11 Consequently, the “supplies” category is reserved for materials that are consumed, destroyed, or lose their identity during the research process.18

In the context of the Michigan credit, the Department of Treasury has emphasized that while the definition originates in federal law, claimants should not apply other IRC provisions, federal regulations, or federal concepts unless they are applicable under the Michigan Income Tax Act.8 This instruction creates a unique interpretive environment where Michigan-specific case law and prior administrative bulletins regarding the “used or consumed” standard—often developed in the context of sales and use tax exemptions—become highly relevant.18

The distinction between “supplies” and “depreciable property” is often the most contentious area during audits.2 For example, the cost of a prototype is generally treated as a supply expense because it is built to test a concept and is often discarded or rendered useless after testing.2 However, if that same prototype is later repurposed as a production tool or sold as a finished product, the Department of Treasury may challenge its classification as a supply.21

The “Used or Consumed” Standard: A Michigan Interpretation

Michigan’s interpretation of “supplies used or consumed” is deeply rooted in its long-standing Industrial Processing (IP) tax framework.19 Although the R&D credit is a relatively new addition to the state’s tax code, the concept of “consumption” in a technical or industrial setting has been extensively refined through the General Sales Tax Act and the Use Tax Act.18 The term “consumed” in Michigan tax law implies a physical transformation or the exhaustion of the property’s utility during an exempt activity.18

In the case of Elias Brothers Restaurants, Inc. v. Treasury Department, the Michigan Supreme Court established that the industrial processing exemption depends on the use to which the property is put, rather than the identity of the taxpayer.18 This principle is directly applicable to the R&D credit: the eligibility of a supply expense is determined by its role in the “process of experimentation”.16 If a material is used to eliminate technical uncertainty—such as determining the durability of a new alloy—it is considered “used or consumed” in qualified research.1

The Department of Treasury’s Revenue Administrative Bulletin (RAB) 2000-4 provides further clarity by defining the boundaries of industrial processing, which include research and experimental activities.20 According to this guidance, research and development ends once the finished goods first “come to rest in finished goods inventory storage”.19 This means that supplies used for testing before a product reaches its final design phase qualify as R&D supplies, whereas supplies used for routine quality control of already-manufactured goods are taxable and ineligible for the R&D credit.20

The application of this standard across different sectors reveals its complexity:

• Manufacturing: Steel or plastic resins used to create multiple iterations of a part to find the optimal weight-to-strength ratio are qualifying supplies.2
• Life Sciences: Chemical compounds, test tubes, and biological cultures that are used in clinical trials or lab experiments are consumed and thus qualify.2
• Software Development: While software itself is often intangible, the rental of off-site or cloud-based server space for the design or testing of new software is specifically treated as a qualifying expense in Michigan, mirroring federal treatment of “rented computer” supplies.2

The physical location of the consumption is paramount. Michigan law requires that the supplies be used or consumed at a facility in Michigan.1 If a Michigan-based company purchases materials in the state but ships them to a laboratory in Ohio for testing, those supply costs are ineligible for the Michigan R&D credit, regardless of where the purchase took place.2

State Revenue Office Guidance: The 2025 Notice and Administrative Roadmap

On April 2, 2025, the Michigan Department of Treasury published the “Notice Regarding New Research and Development Credit,” which serves as the foundational administrative guidance for the program.8 This notice confirms the state’s intent to issue a formal Revenue Administrative Bulletin (RAB) to provide more comprehensive interpretations of the law, but in the interim, the 2025 Notice outlines the immediate requirements for taxpayers.8

A critical takeaway from the Treasury’s guidance is the emphasis on actual, not estimated, expenses.8 Because the state must manage a $100 million aggregate cap, it requires taxpayers to submit “tentative claims” that reflect the actual R&D activities conducted during the calendar year.8 This requirement poses a significant challenge for businesses that do not have robust, real-time tracking systems for their supply inventory.2

The Treasury has also clarified the eligibility of different entity types. While the credit is available to Corporate Income Tax (CIT) payers and flow-through entities filing withholding tax returns, it is specifically unavailable to disregarded entities or those filing under the Michigan Business Tax (MBT) Act due to a certificated credit election.12 Furthermore, the Treasury guidance specifies that for Unitary Business Groups (UBGs), all calculations—including employee counts and base amounts—must be performed at the group level.8

The Treasury’s role in the proration process is another vital component of the guidance. If the aggregate value of all tentative claims exceeds $100 million, the Department is statutorily required to reduce the awarded credits on a pro rata basis.3 For small businesses, this proration only triggers if their combined claims exceed $25 million.3 For large businesses, any remaining balance of the total $100 million cap (after the small business allocation) is distributed pro rata.5 This uncertainty means that even if a business perfectly identifies its “supplies used or consumed,” the final credit amount may be lower than the unadjusted calculation.2

Calculation Mechanics: The Role of the Base Amount

The Michigan R&D credit is an incremental credit, meaning it is designed to reward businesses that increase their research spending over time.2 This is achieved through the use of a “base amount,” which acts as a threshold for the higher credit rates.5 For Michigan purposes, the base amount is defined as the average annual amount of qualifying research expenses incurred during the three calendar years immediately preceding the tax year for which the credit is claimed.4

For a taxpayer claiming the credit for the 2025 tax year, the base amount is calculated using the average Michigan QREs from 2022, 2023, and 2024.5 This calculation differs from the federal Alternative Simplified Credit (ASC) method, which uses a base amount equal to 50% of the average QREs for the prior three years.4 Michigan’s use of 100% of the prior three-year average creates a higher hurdle for taxpayers to reach the “excess” credit rates.4

$$Base\ Amount = \frac{QRE_{2022} + QRE_{2023} + QRE_{2024}}{3}$$

The Treasury has acknowledged potential “drafting errors” in the legislation regarding businesses that were not in existence for the full three-year base period.12 Currently, if a business only has one year of R&D expenses in the base period, that single year’s total is used as the base amount, rather than being divided by three.8 This could unfairly penalize growing firms by artificially inflating their base amount. However, for completely new businesses with no prior research history, the base amount is zero, allowing them to claim the full “excess” rate on all current-year expenses.2

Crucially, the Treasury guidance mandates that these calculations be performed on a calendar-year basis, regardless of the taxpayer’s fiscal year.2 This means a business with a fiscal year ending June 30 must still calculate its 2025 credit based on expenses incurred from January 1, 2025, through December 31, 2025.2 To assist fiscal-year filers, the Treasury plans to develop an optional method to convert fiscal-year data into calendar-year equivalent expenses for the base period years prior to 2025.8

The Geographic Nexus: “In Michigan” Requirements

The most significant constraint on the Michigan R&D credit is the geographic requirement.8 Qualifying research expenses are defined as those under IRC Section 41(b) but only for research conducted in Michigan.5 This restriction applies to all three categories of QREs:

• Wages: Must be paid to employees physically performing, supervising, or supporting research at a facility in Michigan.1
• Supplies: Must be “used or consumed” while performing research activities at a facility in Michigan.1
• Contract Research: Only the portion of third-party research conducted physically within Michigan qualifies.1

This “In Michigan” rule creates a documentation burden for multi-state organizations. Supplies purchased from a Michigan vendor but shipped to a research site in California do not qualify.2 Conversely, supplies purchased from an out-of-state vendor but consumed at a Michigan research laboratory do qualify.1 The focus is on where the research activity—and the consumption of the supply—takes place, not the origin of the supply itself.2

For Unitary Business Groups (UBGs), the “In Michigan” rule is applied collectively. The group must aggregate all eligible expenses incurred by its members within the state to determine both the current-year QREs and the Michigan-specific base amount.8 This group-level calculation can be beneficial if some members have increased their R&D spending while others have decreased it, as the net increase across the Michigan-based operations determines the credit.8

Supply Expenses vs. Depreciable Assets: A Technical Distinction

The boundary between a “supply” and a “depreciable asset” is a frequent source of audit adjustments.2 According to IRC Section 41(b)(2)(C), supplies must be tangible property other than land or improvements and must not be “of a character subject to the allowance for depreciation”.11 This means that if an item is treated as a fixed asset on the company’s balance sheet and depreciated over its useful life, it cannot be included as an R&D supply expense.11

In the case of Union Carbide Corp. v. Commissioner, the court explored the distinction between direct and indirect research costs.28 The government argued that allowing a credit for supplies that would have been incurred regardless of the research (such as those used in a production process that was already in use) would result in a “windfall” for the taxpayer.28 The Second Circuit affirmed that the credit is only available for the costs of supplies that would not have been incurred but for the research activity.28

However, other cases have been more taxpayer-friendly regarding prototypes. In TG Missouri Corp. v. Commissioner, the Tax Court found that supplies purchased from a third party to construct a product for resale could still be qualified research expenses if they were used in an investigative nature to eliminate uncertainty.22 This is a critical point for Michigan manufacturers: even if a prototype is eventually sold to a customer, the materials used to build it may still qualify as R&D supplies if the primary purpose of building it was to test a design or methodology where uncertainty existed.16

The “character of depreciation” test is objective. If an item could be depreciated under Section 167, it is excluded from the definition of supplies, regardless of whether the taxpayer actually chooses to depreciate it.11 This includes “capital items” like machinery, computers (unless rented), and tools with a life exceeding one year.10

Integration with Michigan Sales and Use Tax

A strategic advantage for Michigan businesses is the potential to “double dip” on tax benefits through the Industrial Processing (IP) exemption.19 Under Michigan Compiled Laws Section 205.54t, the sale of tangible personal property to an industrial processor for use or consumption in industrial processing is exempt from sales and use tax.19 Because the definition of “industrial processing” includes research and experimental activities, many of the same supplies that qualify for the R&D credit are also eligible for the sales tax exemption at the point of purchase.19

To qualify for the IP exemption, property must be “used or consumed” in an activity that changes the “form, composition, quality, combination, or character” of tangible personal property for ultimate sale at retail.19 This closely aligns with the R&D “process of experimentation”.16 Examples of property qualifying for the IP exemption—and often the R&D credit—include:

• Property consumed or destroyed during the research process.19
• Fuel or energy used or consumed for an industrial processing activity (segregated from general use).19
• Computers used in operating industrial processing equipment or in a computer-assisted manufacturing system.19

However, the IP exemption is calculated on a percentage-of-use basis.20 For example, if a computer is used 40% of the time to draft plans for exempt research equipment and 60% for building expansion (which is taxable), only 40% of the computer’s cost is exempt from sales tax.21 While the R&D income tax credit excludes depreciable computers entirely (unless they are rented cloud/server space), this percentage-of-use concept is a useful analogy for how the Treasury may audit the allocation of supplies between qualifying R&D and non-qualifying production or administration.20

Administrative Procedures: The Tentative Claim and Proration

Michigan’s R&D credit is not a “file and forget” incentive. It requires a proactive, two-step filing process that is unique among state R&D credits.2 The first and most critical step is the tentative claim.4

The Tentative Claim Process

For the 2025 tax year, all claimants—including corporate and flow-through entities—must submit a tentative claim to the Department of Treasury by April 1, 2026.4 For all subsequent years, the deadline moves to March 15 of the following year.2 The tentative claim must be submitted in the “form and manner prescribed by the Department,” likely through the Michigan Treasury Online (MTO) platform.2

The tentative claim must include:

1. Total Qualifying Research Expenses: Broken down by category, including supplies.1
2. Base Amount Calculation: The three-year historical average of Michigan QREs.2
3. Employee Count: Verification of whether the taxpayer has more or less than 250 employees.1
4. University Collaboration: Identification of expenses incurred under a written agreement with a Michigan research university.4

A taxpayer that fails to file a timely tentative claim is statutorily ineligible to claim the credit on their annual return for that year.2 Because the claims are used for proration, the Treasury will not accept late submissions under any circumstances.8

Proration and the Statewide Cap

The total annual cap for the Michigan R&D credit is $100 million.3 If the total amount of all tentative claims exceeds this cap, the Treasury must adjust the credits as follows:

• Small Business Reserve: $25 million is reserved for businesses with fewer than 250 employees.3 If small business claims are under $25 million, they are not prorated.5 If they exceed $25 million, each small business’s credit is reduced pro rata to fit within the $25 million pool.5
• Large Business Pool: Large businesses share the remaining $75 million (plus any unused portion of the small business reserve).5 If their total claims exceed this amount, their credits are reduced pro rata.5

The Treasury anticipates publishing a notice on its website by April 30 each year, informing taxpayers of the proration factor.8 Taxpayers then use this “adjusted credit amount” on their actual corporate income tax or withholding tax returns.8

Collaborative Research: University Bonuses and Supply Usage

To encourage deeper ties between industry and the state’s higher education system, Michigan offers an “Additional Credit” for university collaboration.3 This bonus is equal to 5% of the qualifying research expenses incurred in collaboration with a Michigan research university pursuant to a written agreement.3

This 5% bonus is available to both small and large taxpayers and is in addition to the standard credit.4 For example, a small business with excess R&D spending could effectively receive a 20% credit (15% standard + 5% bonus) on its collaborative expenditures.7 The additional credit is capped at $200,000 per year per taxpayer.3

In the context of “supplies,” this bonus is particularly relevant for startups that use university lab space and materials.2 If a company pays a university to use its cleanroom and consumes specialized materials provided by the university during the research, those costs may qualify as collaborative QREs.1 However, the taxpayer must maintain a copy of the written agreement with the research university and be prepared to provide it to the Department of Treasury upon request.4

Case Study: Advanced Battery Prototyping in Michigan

To visualize the practical application of the “supplies used or consumed” standard, consider a hypothetical lithium-ion battery startup based in Grand Rapids, Michigan. The company, “L-Power,” has 40 employees and is in its fourth year of operation.

Identifying Qualifying Supplies

In 2025, L-Power focuses on developing a new solid-state electrolyte. Their 2025 expenditures include:

1. Chemical Powders (Lithium Lanthanum Zirconate): $120,000 for materials used to create experimental electrolyte pellets. These pellets are destroyed during conductivity testing. (Qualifies as R&D Supply).2
2. Prototype Casings: $30,000 for custom stainless steel battery housings built to test different internal geometries. (Qualifies as R&D Supply).3
3. Specialized Testing Microscope: $150,000 purchase. Because this is a capital asset with a 5-year useful life, it is subject to depreciation. (Does Not Qualify as Supply).11
4. AWS High-Performance Computing: $20,000 for cloud-based thermal modeling of the battery cells. (Qualifies as “Rented Computer” Supply equivalent).3

Calculating the Michigan Credit

L-Power’s Michigan QREs for the base period (2022-2024) were $100,000 per year, making their base amount $100,000.5 Their total 2025 QREs (including wages and the supplies above) total $400,000.

• Total 2025 QREs: $400,000.
• Base Amount: $100,000.
• Excess QREs: $300,000 ($400,000 – $100,000).

Unadjusted Credit Calculation (Small Taxpayer):

• 3% of Base ($100,000) = $3,000.
• 15% of Excess ($300,000) = $45,000.
• Total Unadjusted Credit: $48,000.

L-Power must file a tentative claim for $48,000 by April 1, 2026.4 If the statewide small business claims total $20 million (below the $25M cap), L-Power will receive the full $48,000 as a refundable credit on their annual return.5

The Impact of Decoupling from IRC Section 174

A major tax planning consideration for Michigan businesses is the state’s decoupling from the federal treatment of R&E (Research and Experimental) expenses under Section 174.3 At the federal level, for tax years beginning in 2025, the “One Big Beautiful Bill” (OBBBA) has restored the ability for businesses to immediately expense domestic R&D costs.12

However, Michigan enacted HB 4961 in October 2025, which explicitly states that for Michigan tax purposes, R&D costs—including supplies—must still be capitalized and amortized over a five-year period for domestic activities (and 15 years for foreign).3 This creates a temporary unfavorable adjustment for Michigan businesses compared to their federal returns.3

The new R&D credit is effectively the state’s mechanism to mitigate the financial impact of this amortization requirement.3 Because the credit is refundable, it provides immediate cash flow that can offset the increased tax liability caused by the inability to immediately deduct research supplies.3

Unitary Business Groups and Flow-Through Entities

The Michigan Department of Treasury has provided specific guidance for complex business structures.8 For Unitary Business Groups (UBGs), the UBG itself is considered the taxpayer, and all calculations are performed at the group level.8 This means the 250-employee threshold applies to the entire group, and the $2 million annual cap is a group-level limit.5 If one member of a UBG conducts research in Michigan and another conducts it in another state, only the Michigan member’s expenses and base amount contribute to the credit.8

For Flow-Through Entities (FTEs), the credit is claimed at the entity level against the withholding tax rather than being passed through to individual partners or shareholders.2 An FTE filing a withholding tax return would claim the credit with its annual withholding return, which is typically due on February 28 following the year the tentative claim was filed.3 FTEs have the option to begin reducing their periodic withholding payments as soon as the Treasury issues the tentative claim adjustment notice in April, providing immediate liquidity for the business.3

Substantiation and Audit Strategy

Given the $100 million annual cap and the refundable nature of the credit, the Michigan Department of Treasury is expected to be vigilant in its audit procedures.2 Taxpayers must maintain contemporaneous documentation that links every dollar of supply spending to a specific qualified research project conducted in Michigan.2

Documentation Recommendations

Best practices for substantiating “supplies used or consumed” include:

• Project-Specific Invoicing: Requesting that vendors list the project name or internal job code on invoices for raw materials.2
• Internal Requisition Logs: Maintaining a digital or physical log that tracks the withdrawal of materials from general inventory for use in a specific R&D lab or project.2
• Prototype Inventory: Taking photographs of prototypes at various stages of construction and testing, and maintaining records of their eventual destruction or disposal.2
• Technical Uncertainties Record: Documenting the specific technical uncertainty (capability, method, or design) that each supply was used to resolve.16
• Time Tracking: While this specifically applies to wages, maintaining time logs for employees who used the supplies helps build the “nexus” between the supply expense and the qualified activity.2

The Treasury requires records to be kept for at least four years, but given the carryforward and proration complexities, a six-year retention policy for R&D documentation is generally considered a safer professional standard.2

Conclusion

The reestablishment of the Michigan R&D tax credit in 2025 provides a vital financial lever for the state’s innovative sectors, yet its success for individual taxpayers hinges on the precise identification and documentation of “supplies used or consumed.” By adhering to the federal IRC Section 41(b) definition while navigating Michigan’s unique in-state performance requirements and calendar-year calculation mandates, businesses can effectively reduce their effective tax rate and mitigate the burden of state-level R&D amortization. The April 1 tentative claim deadline represents a non-negotiable gateway to these benefits, making real-time tracking of prototype materials and experimental consumables a critical operational priority. As the Department of Treasury prepares to release more formal guidance through Revenue Administrative Bulletins, taxpayers should proactively align their accounting practices with the “used or consumed” standard to ensure they are prepared for the competitive proration process and the inevitable scrutiny of state audits. Strategies that integrate the R&D credit with the existing industrial processing sales tax exemption will offer the most significant aggregate tax savings, reinforcing Michigan’s competitive position as a leader in the next generation of industrial technology and manufacturing.

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