Analysis of Basic Research Payments within the Minnesota Credit for Increasing Research Activities

Basic Research Payments represent capital outlays made to qualified universities or non-profit scientific organizations for original investigations that advance scientific knowledge without specific commercial objectives. Within the Minnesota tax framework, these payments constitute a distinct category of qualified research expenses that allow businesses to claim a tiered tax credit against corporate franchise or individual income tax liabilities for research conducted in the state.

The Minnesota Credit for Increasing Research Activities, codified under Minnesota Statutes § 290.068, serves as a primary fiscal instrument for incentivizing technological innovation and academic collaboration within the North Star State.1 While the credit is largely patterned after the federal research credit established under Section 41 of the Internal Revenue Code (IRC), the Minnesota application introduces specific geographic constraints, unique tiered rate structures, and evolving refundability provisions that require nuanced understanding for compliance and optimization.3 Central to this incentive is the concept of “Qualified Research Expenses” (QREs), a broad umbrella that includes in-house wages, supplies, and contract research, as well as the specialized “Basic Research Payments” (BRP) made to external academic and scientific institutions.5

The legal distinction between general qualified research and basic research is fundamental to the tax treatment of these expenditures. Under IRC § 41(e), which Minnesota adopts by reference, basic research is defined by its foundational nature—it is research intended to uncover new scientific principles rather than the immediate development of a commercial product.6 For Minnesota businesses, these payments are not merely deductible expenses but are integrated into a complex, incremental credit calculation designed to reward sustained and increased investment in the state’s research infrastructure.3

Legislative Foundation and Statutory Framework of Section 290.068

The Minnesota Legislature established the research tax credit in 1981, aligning state policy with the then-nascent federal effort to stimulate private sector R&D.4 The overarching objective of the credit is to foster job creation, retain high-tech industries, and increase the overall volume of research activity within Minnesota’s borders.4 Since its inception, the statute has undergone several significant revisions, most notably regarding the percentage of the credit, the types of entities eligible to claim it, and the mechanism for monetization.3

Eligibility and Entity Classification

The credit is available to a wide array of business structures, provided they incur qualified research expenses within Minnesota. This includes C corporations, which apply the credit against the corporate franchise tax, and pass-through entities such as S corporations, partnerships, and LLCs, where the credit flows through to individual shareholders or partners to reduce their individual income tax liabilities.1 For unitary business groups, Minnesota law allows for the sharing of credits among members of the combined group, a provision that has been clarified through recent Department of Revenue (MDOR) guidance to include the sharing of credit carryovers.1

Table 1: Entity Eligibility and Credit Application for the Minnesota R&D Credit.1

Geographic Nexus and the “In-State” Requirement

A non-negotiable requirement of the Minnesota R&D tax credit is that the research must be conducted entirely within the state.10 While the federal credit allows for research conducted anywhere in the United States, Minnesota Statutes § 290.068 specifically excludes any expenses for research performed outside the state.2 This geographic limitation applies strictly to Basic Research Payments; if a Minnesota-based firm pays a university in North Dakota to perform scientific investigations, those payments are ineligible for the Minnesota credit, regardless of the firm’s headquarters location.9

Defining Basic Research Payments under Federal and State Guidance

To understand Basic Research Payments, one must look to the federal definitions found in IRC § 41(e) and the corresponding Treasury Regulations. Basic research is defined as “any original investigation for the advancement of scientific knowledge not having a specific commercial objective”.6 This definition excludes research in the social sciences, arts, or humanities, as well as research conducted outside the United States.6

Qualified Organizations for Basic Research

For a payment to qualify as a BRP under Section 290.068, it must be made to a “qualified organization” pursuant to a written contract.6 The Internal Revenue Code categorizes these organizations into four distinct types:

1. Educational Institutions: Colleges and universities that meet the requirements of IRC § 170(b)(1)(A)(ii). In the Minnesota context, these must be institutions conducting research within state boundaries.6
2. Scientific Research Organizations: Entities organized and operated primarily to conduct scientific research that are not private foundations.6
3. Grant-Giving Organizations: Certain non-profit organizations that are organized and operated primarily to promote scientific research by making grants to educational institutions.6
4. Scientific Societies: Certain organizations exempt from tax under IRC § 501(c)(3) or (6) that are organized primarily to promote scientific research.6

Distinction from Contract Research

While “contract research” involves paying a third party to perform research on behalf of the taxpayer, BRPs are handled differently in the credit calculation. Standard contract research expenses are typically includable at only 65% of the amount paid.13 However, Basic Research Payments are generally includable at 100% of the payment, although they are subject to a “base period” reduction known as the Qualified Organization Base Period Amount (QOBPA) at the federal level.6 Minnesota follows this inclusion logic, requiring taxpayers to enter the full amount paid to qualified organizations on Line 5 of Schedule RD.5

The Mechanics of the Minnesota R&D Credit Calculation

The Minnesota credit is calculated using a regular incremental method, which compares current-year qualified research expenses against a historical “base amount”.3 Unlike the federal government, Minnesota does not currently allow the use of the Alternative Simplified Credit (ASC) method, although there has been significant legislative interest in adopting it to simplify the process for taxpayers.12

The Tiered Rate Structure

The credit is unique in its tiered approach, which provides a higher incentive for initial investments and a lower rate for expenditures exceeding a specific threshold.10 For taxable years beginning after December 31, 2016, the rates are:

• 10 percent of the first $2,000,000 of the excess of qualified research expenses over the base amount.1
• 4 percent of the excess research expenses over $2,000,000.3

Prior to 2017, the secondary tier rate was 2.5%, and some older statutes or summaries may still reflect this legacy rate, but current filings must use the 4% figure.9

Calculating the Base Amount

The base amount represents the threshold that a company must exceed to qualify for the credit. It is calculated as the product of the “fixed-base percentage” and the average annual Minnesota gross receipts for the four preceding years.3

The fixed-base percentage is determined based on the taxpayer’s history:

• Established Firms: For companies that had both gross receipts and QREs in at least three tax years between 1984 and 1988, the percentage is the ratio of aggregate QREs to aggregate gross receipts for those years, capped at 16%.14
• Start-up Companies: For firms beginning after 1988, the percentage is initially set at 3% and adjusts according to a specific federal schedule over a ten-year period.14

Importantly, the base amount can never be less than 50% of the current-year qualified research expenses.3 This “50-percent limit” ensures that even companies with exceptionally low historical spending are somewhat limited in the credit they can claim relative to their current-year budget.3

The Role of Minnesota Gross Receipts

A critical compliance point for multistate businesses is the definition of “gross receipts.” For the Minnesota credit, the taxpayer must use Minnesota-specific sales or receipts as defined under § 290.191.1 This often leads to a lower base amount for companies with high research spending in Minnesota but significant national sales, thereby increasing the “excess” over the base amount and the resulting credit.3

Administrative Guidance: Completing Schedule RD

The Minnesota Department of Revenue provides Schedule RD as the primary form for claiming the credit. The form requires a meticulous breakdown of expenses to ensure they meet both federal definitions and state geographic requirements.5

Line-by-Line Breakdown of Expenses

Taxpayers must aggregate their Minnesota-based expenses across six categories on the initial lines of Schedule RD:

• Line 1: Wages. This includes compensation for employees directly performing, supervising, or supporting research.5
• Line 2: Supplies. Costs for tangible property used in the research process, excluding land and depreciable property.5
• Line 3: Computer Rental/Cloud Costs. Amounts paid for the right to use computers to conduct research, frequently used now for cloud-based development environments.5
• Line 4: Contract Expenses. 65% of payments made to third parties for qualified research.5
• Line 5: Basic Research Payments. Payments made to qualified research organizations.5
• Line 6: Nonprofit Contributions. Contributions to Minnesota nonprofits that provide grants to early-stage innovative enterprises.10

Substantiation and Documentation Standards

MDOR guidance emphasizes that taxpayers must maintain comprehensive records to support their claims. The “Four-Part Test” from IRC § 41(d) must be met for every project included in the QRE calculation.20

To meet the “Elimination of Uncertainty” test, the research must aim to discover information that resolves technical uncertainty regarding the capability, method, or design of a product or process.10 For Basic Research Payments specifically, the taxpayer should maintain the following:

• Written Contracts: Formal agreements with the university or scientific organization.6
• Project Documentation: Reports or peer-reviewed articles resulting from the basic research that demonstrate its foundational, scientific nature.10
• Proof of Payment: Documentation showing that the cash payments were made within the tax year.6

MDOR often identifies common errors during audits, such as claiming expenses for research performed at a request of another entity (where the taxpayer does not retain substantial rights) or failing to exclude “style, taste, or cosmetic” improvements.4

The Evolution of Refundability in Minnesota

Perhaps the most significant change in the R&D credit landscape is the transition between refundable and non-refundable status. The state’s policy in this area has historically reflected a balance between economic stimulus and fiscal conservatism.1

Historical Context (2010–2012)

From 2010 through 2012, the Minnesota R&D tax credit was fully refundable. This was a temporary provision intended to stimulate the state economy following the 2008 financial crisis.1 During this period, companies with zero tax liability could receive the full amount of the credit as a check from the state. This provision was repealed for tax years beginning in 2013, returning the credit to a non-refundable carryforward status.1

The 2025 Refundability Pivot

Beginning in tax year 2025, Minnesota is reintroducing a “Partial Refund” option. This legislative change is specifically aimed at supporting startups and R&D-heavy firms that may be years away from profitability and thus have no immediate tax liability to offset.17

Taxpayers must make an irrevocable election on a timely filed return to receive the refund.17 The refund amount is calculated after the credit has been used to reduce the current year’s tax liability to zero. The unused portion of the current year’s credit is then multiplied by a refundability rate.10

Table 2: Refundability Rates and Targets under 2025 Legislative Changes.17

This shift is expected to significantly increase the liquidity of innovative firms in Minnesota, as they can now monetize at least a quarter of their unused credits annually rather than carrying them forward for the full 15-year window.17

Unitary Business Groups and Credit Allocation

Minnesota’s corporate tax system utilizes unitary reporting, meaning that businesses under common control and part of a single economic unit file a combined report.1 The application of the R&D credit within these groups is a complex area of tax law that has seen recent administrative updates.

Sharing of Credits Among Group Members

Under current Minnesota statute, the research credit is primarily generated by the entity that incurred the qualified research expenses (the “earning member”). However, if the earning member’s credit exceeds its own tax liability, the excess may be shared with other members of the unitary group who have tax liabilities.1

The application hierarchy for a generated credit is as follows:

1. Apply the current-year credit to the earning member’s tax liability.1
2. Apply any remaining credit to the tax liabilities of other members of the combined group.1
3. Any remaining unused credit is carried forward by the earning member.1

The 2020 Guidance on Credit Carryovers

On June 18, 2020, the MDOR issued a significant update regarding the sharing of credit carryovers. Previously, the instructions for Schedule RD suggested that carryover credits could only be used by the specific entity that earned them.1 The 2020 update modified this, clarifying that credit carryovers must be shared with other members of the combined group in subsequent years, just as the current-year credit is shared in the generation year.1 This change prevents “trapped” credits in loss-making subsidiaries when other members of the unitary group are profitable.1

Fiscal and Economic Impact of the Credit

The Credit for Increasing Research Activities represents a significant tax expenditure for the State of Minnesota. The 2024 Tax Expenditure Budget provides detailed insights into the cost and distribution of the credit.3

Annual Cost to the General Fund

The cost of the credit has risen markedly in recent years, driven by increased research budgets and the higher secondary tier rate.3

Table 3: Minnesota Research and Development Tax Credit Expenditure Budget.3

Industry Concentration

The manufacturing sector remains the primary beneficiary of the credit, claiming approximately 65% of the total amount.4 Software and electronics are also significant contributors. Among C corporations, the largest 20% of claimants (measured by sales) received two-thirds of the total credit, highlighting the credit’s importance to Minnesota’s established corporate giants.4

Evaluation of Effectiveness

The Office of the Legislative Auditor (OLA) has noted that while the credit attracts and retains high-paying jobs, its net fiscal benefit is lower than the total amount of credits claimed.4 This has led to recommendations that the Legislature establish more explicit, measurable objectives for the credit to better evaluate its performance.4 The 2021 creation of the Tax Expenditure Review Commission is a step toward this more rigorous evaluation.25

Example Calculation: Integration of Basic Research Payments

To clarify the interaction of BRPs and the tiered credit, consider a hypothetical Minnesota-based biotechnology firm.

Company Profile and Expenses

For the 2024 tax year, “MN Biotech Inc.” incurs the following expenses within the state:

• Qualified Wages (In-house): $1,500,000
• Research Supplies: $300,000
• Basic Research Payments (University of Minnesota Contract): $400,000
• Contract Research (to an unrelated local lab): $100,000 (included at 65% = $65,000)
• Total Minnesota QREs: $2,265,000

The company has determined its “Base Amount” to be $1,000,000 based on its fixed-base percentage and prior four years of Minnesota gross receipts.17

Step 1: Calculate the Excess Research Expenses

The credit applies to the expenses that exceed the base amount.

$$Excess = Total QREs – Base Amount$$

$$Excess = \$2,265,000 – \$1,000,000 = \$1,265,000$$

Step 2: Apply the Tiered Rates

Since the excess of $1,265,000$ is less than the $2,000,000$ threshold, the entire amount is subject to the 10% rate.10

$$Credit = \$1,265,000 \times 10\% = \$126,500$$

Scenario B: Higher Spending

If the company instead had $3,500,000$ in total QREs with the same $1,000,000$ base amount:

$$Excess = \$3,500,000 – \$1,000,000 = \$2,500,000$$

The calculation then splits into two tiers:

1. Tier 1 (First $2M): $\$2,000,000 \times 10\% = \$200,000$
2. Tier 2 (Over $2M): $(\$2,500,000 – \$2,000,000) \times 4\% = \$500,000 \times 4\% = \$20,000$
3. Total Credit: $\$200,000 + \$20,000 = \$220,000$ 17

Interaction with Federal BRP Credits

On the federal return (Form 6765), the Basic Research Payments of $400,000 would be subject to a different calculation involving the QOBPA, which might further reduce the amount. However, for the Minnesota Schedule RD, the taxpayer enters the full $400,000 on Line 5, contributing to the total QREs that are then compared to the Minnesota base amount.5

Strategic Considerations for Minnesota Taxpayers

The inclusion of Basic Research Payments offers a unique opportunity for companies to leverage Minnesota’s academic talent while maximizing tax benefits. Because BRPs are generally included at 100% of the cost (subject to the base amount comparison) compared to the 65% limit for standard contract research, there is a distinct financial incentive to engage with educational institutions and non-profit scientific organizations rather than private for-profit labs.6

Interaction with IRC Section 174 Amortization

Beginning in 2022, a major federal change required businesses to amortize research and experimental costs over five years (for domestic research) rather than deducting them in the year incurred.3 Minnesota has conformed to this federal change. This adds a layer of complexity to cash flow planning, as the immediate tax deduction is reduced, making the R&D tax credit even more critical as a primary source of immediate tax relief.3

The Innovation Grant Exception

Taxpayers should be aware that expenditures funded by “Innovation Grants” from the Minnesota Department of Employment and Economic Development (DEED) are specifically excluded from the QRE calculation.10 If a company receives a state grant to fund a project at the University of Minnesota, the portion of the BRP covered by that grant cannot be claimed as a qualified research expense for the R&D tax credit.5

Comparisons with Other Jurisdictions

Minnesota’s R&D tax credit is more generous than several neighboring states but more restrictive than some coastal innovation hubs.

• Wisconsin: Offers a credit based on a percentage of QREs, but its definition of qualified activities is somewhat more narrow.27
• California: Provides a 15% credit (higher than MN’s 10%) and offers a specialized 24% credit for university-based basic research.27
• Arizona: Offers a 24% credit for the first $2.5 million of QREs, significantly higher than Minnesota, and allows the ASC method.28

Minnesota’s tiered rate of 10% on the first $2 million is specifically designed to be highly competitive for mid-market companies and startups, which are seen as the primary engines of the state’s future economic growth.17

Conclusion

The Minnesota Credit for Increasing Research Activities provides a vital mechanism for reducing the cost of innovation within the state. By integrating Basic Research Payments into the statutory framework, Minnesota incentivizes a collaborative ecosystem where private enterprises support and benefit from the foundational scientific work of universities and non-profit organizations. While the calculation involves complex “base amount” formulas and requires strict adherence to geographic nexus rules, the 2025 shift toward partial refundability represents a landmark modernization of the code, ensuring that pre-revenue startups can realize immediate value from their research investments.22

For businesses operating in Minnesota, compliance hinges on thorough documentation, accurate entity-level tracking within unitary groups, and a clear distinction between routine development and the systematic process of experimentation mandated by the Four-Part Test. As the state continues to evaluate the fiscal efficiency of these expenditures through the Tax Expenditure Review Commission, the R&D credit remains a cornerstone of the North Star State’s appeal as a center for global technology and manufacturing excellence.4

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