Analysis of Carry Forward Mechanisms within the Minnesota Research and Development Tax Credit Framework

In the context of the Minnesota Research and Development (R&D) tax credit, a carry forward is the statutory provision that permits a taxpayer to apply unused credit amounts to offset tax liabilities in up to 15 future taxable years. This mechanism ensures that businesses with qualifying research expenses in excess of their current tax obligations can preserve the economic value of those credits and utilize them as their profitability increases over time.1

The Minnesota Credit for Increasing Research Activities, codified under Minnesota Statutes Section 290.068, represents a significant investment by the state to foster innovation and economic growth. While the primary goal of the credit is to incentivize immediate spending on qualified research, the practical reality of many research-intensive businesses—particularly in the biotechnology, medical device, and software sectors—is that significant research expenditures often occur years before a company generates a taxable profit. Without a robust carry forward provision, the R&D credit would effectively lose its utility for startups and cyclical industries. Consequently, the carry forward serves as a long-term tax asset on a company’s balance sheet, subject to rigorous documentation standards and specific ordering rules mandated by the Minnesota Department of Revenue (MDOR).2

Statutory Foundation and Legal Architecture of the Credit

The Minnesota R&D credit was established by the state legislature in 1981, patterned after the federal research credit found in Section 41 of the Internal Revenue Code (IRC).5 The legal foundation of the credit is an “incremental” model, meaning the credit is not granted for all research spending, but only for the increase in spending over a calculated “base amount.” This structure is intended to prevent the state from subsidizing research that a business would have conducted anyway as part of its normal operations.6

The Core Formula and Tiered Rates

According to Minnesota Statutes Section 290.068, Subdivision 1, a corporation or individual shareholder/partner is allowed a credit against the tax for the taxable year equal to a tiered percentage of their excess qualifying research expenses (QREs) over their base amount.1

Source: 1

For tax years beginning after December 31, 2016, the rate for expenses exceeding the $2,000,000 threshold was set at 4%, a significant increase from the historical rate of 2.5%, which still appears in older summaries of the law.1 This change reflects a legislative desire to increase the attractiveness of Minnesota for larger, more capital-intensive research projects that regularly exceed the $2 million mark.

Qualifying Research Expenses and the Minnesota Nexus

To generate a credit that can eventually be carried forward, a taxpayer must first incur “Qualified Research Expenses” (QREs). Minnesota law largely adopts the definitions found in IRC Section 41(b) and (e), but with one critical and absolute limitation: the research must be conducted within the state of Minnesota.1

Expenses that qualify for the credit and potential carry forward include:

• Wages: Salaries and benefits for employees directly performing, supervising, or supporting research activities.8
• Supplies: Tangible property consumed in the research process, such as chemicals, prototypes, or testing materials; this excludes land, depreciable property, and general administrative items.2
• Contract Research: 65% of the amount paid to third parties for research conducted on the taxpayer’s behalf, provided the contractor performs the work in Minnesota.4
• Computer Use: Amounts paid for the right to use computers to conduct research, including cloud computing and server time utilized for simulations or software development.2
• Nonprofit Contributions: Contributions to certain qualified nonprofit organizations that make grants to early-stage technology businesses.2

The “Four-Part Test” derived from federal regulations must also be satisfied for any activity to qualify. The activity must have a permitted purpose (to improve a business component), must seek to eliminate technical uncertainty, must involve a process of experimentation, and must be technological in nature.2

The 15-Year Carry Forward: Mechanics and Limitations

The carry forward provision exists because the Minnesota R&D credit is generally nonrefundable, meaning it can only reduce a taxpayer’s liability to zero but cannot result in a check being issued for the excess.2 For most of the credit’s history, any amount generated in a year without tax liability would simply wait on the books for future use.

The Standard 15-Year Rule

Under Minnesota Statutes Section 290.068, Subdivision 3, if the credit determined for any taxable year exceeds the tax liability for that year, the excess becomes a “research credit carryover” to each of the 15 succeeding taxable years.1

The carryover operates under a “first-in, first-out” chronological priority:

1. Generation Year: The credit is applied to the current year’s liability.
2. Earliest Carryover: Any remaining credit must be carried first to the earliest possible year in which the taxpayer has a tax liability.1
3. Successive Application: The credit is then applied sequentially to each following year until either the credit is exhausted or the 15-year period expires.1

It is important to note that Minnesota does not allow a “carry back” of the R&D credit. Unlike some other state incentives or the federal general business credit, a Minnesota taxpayer cannot apply a current-year credit to a prior year’s return to obtain a refund of taxes already paid.2

Expiration and Value Decay

A carry forward that is not utilized within the 15-year window expires and is lost forever. For businesses, this creates a “use it or lose it” scenario. In a high-inflation environment, the real economic value of a credit carry forward decays over time. A $100,000 credit generated in 2024 but not used until 2039 has significantly less purchasing power than it did at the time of generation. This economic reality has been a primary driver behind the recent legislative shift toward partial refundability.7

Unitary Group Dynamics and Revenue Office Guidance

For large corporate structures filing a combined report as a “unitary business,” the rules regarding carry forwards became significantly more favorable following a landmark 2020 update from the Minnesota Department of Revenue.3

The Problem of “Trapped” Credits

Prior to June 2020, the MDOR’s instructions for Schedule RD suggested that while current-year credits could be shared among members of a unitary group, a carry forward could only be used by the specific legal entity that originally “earned” the credit.3 This meant if “Subsidiary A” generated a large credit but had no income, while “Subsidiary B” had high income but no credit, the credit would be “trapped” as a carryover in Subsidiary A.

The 2020 Policy Shift: Universal Sharing

On June 17, 2020, the MDOR issued updated guidance (reflected in revised instructions for Schedule RD) clarifying that credit carryovers must be applied to all members of a combined return in the same manner as current-year credits.9 This update was effective for all tax years beginning after December 31, 2012.3

The current allocation hierarchy for unitary groups is as follows:

Source: 3

This policy change significantly increased the utilization rate of R&D credits across corporate Minnesota. Taxpayers who were previously denied the ability to share carryovers were permitted to file amended returns (Form M4X) within the 3.5-year statute of limitations to claim refunds for years where they had paid taxes that could have been offset by a group member’s carryover.3

Modernization and the 2025 Partial Refundability Election

Perhaps the most significant change in the 40-year history of the Minnesota R&D credit occurred on June 14, 2025, when H.F. 9 was signed into law.7 This legislation recognized that long-term carry forwards were of limited help to early-stage, cash-strapped innovation companies.

The Mechanism of Partial Refundability

Beginning with tax years that start after December 31, 2024, taxpayers can now elect to receive a partial refund of their unused R&D credits instead of carrying the entire amount forward.1 This provides an immediate cash-flow benefit, though at a discounted rate compared to the full face value of the credit.

The refundable amount is determined by multiplying the unused portion of the current-year credit by a “refundability rate” set by the legislature:

Source: 1

Strategic Election: Refund vs. Carry Forward

The choice between a refund and a carry forward is a critical tax planning decision. According to Minnesota Statutes Section 290.068, Subdivision 3a, the election to receive a refund is irrevocable for that taxable year.1

If a taxpayer elects the refund:

• They receive 19.2% (for 2025) of the unused credit as cash.
• The remaining 80.8% of that specific year’s credit continues to carry forward for up to 15 years.1
• The election must be made on a timely filed return, including extensions.1

This means a taxpayer does not have to give up their entire carry forward to get some cash today. They essentially “sell” a portion of the value back to the state in exchange for immediate liquidity. For many startups, this $19,200 (on a $100,000 credit) is more valuable for making payroll than a $100,000 promise 10 years in the future.

Application to Pass-Through Entities (PTEs)

While the carry forward rules for C corporations center on the unitary group, the rules for S corporations and partnerships revolve around the individual shareholder or partner.4

The Flow-Through Asset

For entities like S-corps and partnerships, the credit is calculated at the entity level on Schedule RD but is then passed through pro-rata to the owners on Schedule KPI or KS.4

• Individual Credits: The individuals report their share of the credit on their Minnesota individual income tax return (Form M1) using Schedule M1C.3
• Individual Carry Forward: If the individual’s share of the credit exceeds their personal tax liability, the carry forward remains with the individual.4
• Refundability Election: For PTEs, the election for the 2025 partial refund must be made by the individual partners, members, or shareholders, not by the entity itself.2

Pass-Through Entity (PTE) Tax Interplay

Minnesota’s recently enacted PTE tax allows a partnership or S-corp to pay tax at the entity level to benefit its owners.15 While this affects how the owner’s income is taxed, the R&D credit generally remains a separate incentive that can be used to offset the owner’s liability or carried forward if that liability is already zeroed out by other means.15

Documentation and Audit Defense for Carryforwards

A tax asset that can last for 15 years requires a unique approach to record retention. The Minnesota Department of Revenue has the power to audit a credit carry forward in the year it is utilized, even if the year it was generated is past the typical 3.5-year statute of limitations for assessing new taxes.2

The Record-Keeping Mandate

The MDOR has provided explicit guidance on the types of records necessary to substantiate a carry forward. Because “wages” typically account for 75% of Minnesota R&D credits, payroll documentation is paramount.5

To survive an audit of a carry forward, a business must maintain:

• Project Lists: Detailed records of the new or improved products/processes, clearly explaining the improvements in function, reliability, or quality.2
• Employee Information: Names, locations (must be in MN), compensation, and time logs or percentage estimates of time spent on qualified activities.8
• Supply Tracking: Invoices and records showing how specific tangible supplies were used in the experimentation process.2
• Third-Party Contracts: Proof that any contracted research was performed within Minnesota and that the taxpayer retained the substantial rights to the research.8

The Statute of Limitations Nuance

The general statute of limitations for Minnesota tax returns is 3.5 years.9 However, if a taxpayer is carrying forward a credit from 2024 to use in 2030, the state may still require the taxpayer to prove the 2024 expenses were valid in 2030. The MDOR’s guidance suggests that taxpayers should align their record-keeping with federal IRC Section 6001 requirements and maintain documentation for as long as the carry forward is active plus the 3.5-year period for the return on which it was finally used.2

The “Base Amount” Challenge for Legacy Businesses

The calculation of the “base amount” is the single greatest determinant of how much credit (and thus how much carryover) a company generates. Minnesota uses a “fixed-base percentage” calculation that can be particularly difficult for older companies.5

Historical Ratios and the 1984-1988 Window

For legacy businesses that existed in the mid-1980s, the “base amount” is calculated using the ratio of their QREs to their gross receipts from the years 1984 through 1988.5

• The Trap: If a company was very research-intensive in the 1980s but its industry has matured, it may have a very high “fixed-base percentage” (capped at 16%). This means it must spend a large percentage of its current revenue on research just to reach its base amount.6
• The Startup Advantage: Companies that started after 1988 are assigned a fixed-base percentage of 3% for their first five years, making it much easier to exceed the base and generate credits and carryforwards.6

The 50% Rule

Under Minnesota law, the base amount cannot be less than 50% of the current year’s qualified research expenses.6 This ensures that even for the most innovative companies, the credit is limited to a percentage of their total current-year research effort. This “50% floor” often results in companies generating smaller credits than they might under federal rules, which in turn limits the size of the carry forward that can be banked for future years.

Administrative Filing and Form Mechanics

To claim and carry forward the credit, taxpayers must navigate a series of specific state forms. The primary vehicle for the claim is Schedule RD, Credit for Increasing Research Activities.2

Schedule RD Structure

The schedule requires a detailed breakdown of expenses and gross receipts over the preceding four years.17

Source: 17

For unitary businesses, a separate Schedule RD must be completed for each corporation in the group that is claiming the credit.17 If a credit is being allocated among group members, the “Designated Filer” for the unitary group must ensure that all payments and refunds are managed under their Minnesota tax ID number.20

Fiscal Impact and Economic Policy Evaluation

The Minnesota Department of Revenue and the Legislative Budget Office periodically evaluate the fiscal impact of the R&D credit and its carry forward provisions. These evaluations are used by the Tax Expenditure Review Commission to determine if the credit is achieving its policy goals of creating jobs and attracting businesses.5

Expenditure Trends

Data from the 2024 Tax Expenditure Budget indicates that the state is prepared for a significant increase in the “cost” of the credit, largely due to the new refundability rules and the continued growth of the state’s technology sector.6

Source: 6

The jump from 2023 to 2024 ($100M to $144M) is reflective of a maturing innovation economy and a legislative environment that has prioritized making these credits more accessible. The carry forward mechanism acts as a “buffer” for the state’s budget; during lean economic years, businesses may generate credits but lack the liability to use them, delaying the fiscal impact on the state’s general fund.5

Policy Objectives: Jobs and Retention

The Legislative Auditor’s office has noted that while the credit is entitled “Credit for Increasing Research Activities,” its broader goals are to create or retain high-paying jobs and to prevent companies from moving their R&D operations to other states like California or Massachusetts, which also offer robust incentives.5 The 15-year carry forward is a central part of this “retention” strategy—it binds a company’s future tax benefits to its continued presence and tax-paying status in Minnesota.

Comprehensive Case Studies: Carry Forward in Action

To fully understand the nuances of the carry forward, it is helpful to examine its application across different corporate life cycles and structures.

Scenario A: The High-Growth Biotech Startup

“MN-Biotech Inc.” is a startup based in Rochester. In 2025, it spends $5,000,000 on research (all in MN) but has no revenue and no tax liability.

• 2025 Credit Generation:

• MN QREs: $5,000,000.
• Base Amount (Startup rule 3% of revenue, but 50% floor applies): $2,500,000.
• Excess QREs: $2,500,000.
• Credit: (10% of $2,000,000) + (4% of $500,000) = $220,000.

• The Decision: MN-Biotech needs cash for laboratory equipment. It elects the 19.2% partial refund.

• Refund Amount: $220,000 x 19.2% = $42,240.
• Carry Forward: $220,000 – $42,240 = $177,760.

• Future Utilization: The $177,760 carryover will sit on MN-Biotech’s books for the next 15 years. If the company becomes profitable in 2029, it can use that entire amount to offset its 2029 tax bill.

Scenario B: The Unitary Manufacturing Group

“Global-Gear Unitary Group” has two entities: a profitable Sales division (Entity S) and an R&D division (Entity R).

• Current Year (2025):

• Entity R generates a $500,000 credit but has $0 liability.
• Entity S has $300,000 in tax liability.

• Allocation: Entity R must share $300,000 of its current-year credit with Entity S. Entity S pays $0 tax.1
• Carry Forward: The remaining $200,000 becomes a carry forward.
• Next Year (2026):

• Entity R (the earning member) now has $50,000 in tax liability.
• Entity S has $400,000 in liability.

• Execution:

1. Entity R uses $50,000 of the carryover to reduce its own tax to zero.
2. The remaining $150,000 of the carryover is allocated to Entity S.
3. Entity S pays $250,000 ($400,000 – $150,000) in tax.

In this scenario, the carry forward was successfully shared across the group to maximize the current tax savings for the entire enterprise.3

Administrative Summary and Final Guidance

Navigating the Minnesota R&D tax credit and its carry forward provisions requires a sophisticated understanding of both statutory law and administrative guidance from the MDOR.

1. Strict Geographical Nexus: Only expenses incurred in Minnesota qualify.1
2. 15-Year Horizon: Carryforwards are valid for 15 succeeding years; there is no carry back.2
3. Group Sharing: Carryforwards can be shared among all members of a unitary group, with the earning member having the first right of use.3
4. The 2025 Shift: Taxpayers can now trade a portion of their carry forward for immediate cash at a rate of 19.2% to 25%.1
5. Documentation is Asset Protection: Because the state can challenge the validity of a carryover in the year of use, contemporaneous records must be maintained for the life of the credit.2

The Minnesota Credit for Increasing Research Activities continues to be a cornerstone of the state’s tax policy. For businesses, the carry forward is not just a passive accounting entry; it is a dynamic tax asset that requires proactive planning, especially in light of the new refundability options enacted in 2025. By understanding the ordering rules, the sharing mechanisms, and the rigorous substantiation requirements, businesses can ensure that their investments in Minnesota innovation yield the maximum possible financial return.

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