Comprehensive Analysis of Minnesota Statutes 290.068: The Credit for Increasing Research Activities

Minnesota Statutes section 290.068 allows businesses to claim a tiered tax credit against corporate franchise or individual income tax for qualified research expenses incurred within the state. This incentive rewards companies that increase their investment in Minnesota-based innovation by providing a credit based on research spending that exceeds a specific historical base amount.1

The statutory framework established under 290.068 serves as a pivotal mechanism in the economic architecture of the North Star State. Since its inception in 1981, the credit has functioned not merely as a fiscal deduction but as a strategic tool designed to anchor high-technology industries and high-paying research jobs within the local economy.3 By aligning closely with the federal definitions provided in Section 41 of the Internal Revenue Code (IRC), the Minnesota credit offers a degree of conformity that simplifies compliance for multi-state entities, yet it introduces unique tiered rates and geographic restrictions that demand a nuanced understanding of state-level administrative guidance.5 This analysis explores the legal nuances of the statute, the rigorous technical tests required for eligibility, and the significant shift in 2025 toward partial refundability, which fundamentally alters the credit’s utility for early-stage and non-profitable firms.7

Statutory Foundation and Legal Evolution

The primary authority for the Minnesota Research and Development (R&D) credit is codified in Minnesota Statute 290.068, entitled “Credit for Increasing Research Activities.” This law provides a tax credit for corporations, partners in a partnership, and shareholders in S corporations.1 The statute is structured to provide an incremental benefit, meaning it does not apply to the total amount of research spending but rather to the increase in such spending over a defined base amount.8

Historically, the Minnesota credit was strictly nonrefundable, meaning it could only be used to offset actual tax liability, with any excess carried forward to future years.1 This changed significantly on June 14, 2025, when Governor Tim Walz signed House File 9 (HF 9) into law.9 This landmark legislation modified Statute 290.068 to introduce partial refundability for the first time, signaling a major policy shift toward supporting startups and companies with low current tax liability that are nonetheless making substantial investments in the state’s technological future.7

Subdivision 1: The Credit Mechanism

Subdivision 1 of the statute defines the basic calculation of the credit. A taxpayer is allowed a credit against the tax computed under the chapter for the taxable year equal to 10 percent of the first $2,000,000 of the “excess” qualified research expenses over the base amount, and 4 percent on all excess expenses over $2,000,000.1 This tiered structure is a critical component of the state’s policy; it provides a highly concentrated 10% incentive for the first $2 million of incremental R&D, which is particularly beneficial for small to mid-sized innovation projects.11 For larger investments, the 4% rate ensures continued support while managing the state’s total tax expenditure.11

The “excess” mentioned in the law represents the difference between the current year’s qualified research expenses and the base amount. If a company does not spend more than its base amount in a given year, it earns zero credit, regardless of its total R&D budget.8 This “incremental” requirement is designed to ensure that the state is subsidizing new or expanded research efforts rather than rewarding a status quo level of activity.8

Subdivision 2: Integrated Definitions

The technical precision of Statute 290.068 is achieved through its definitions in Subdivision 2, which incorporate federal law by reference while imposing state-specific limitations.

• Qualified Research Expenses (QREs): Under Subd. 2(a), QREs include both in-house research expenses and basic research payments as defined in IRC Sections 41(b) and 41(e).1 However, the state imposes a strict “Minnesota-only” rule: expenses incurred for research conducted outside the state are explicitly excluded.1
• Qualified Research: Subd. 2(b) defines this as research that meets the federal definition in IRC Section 41(d), with the same geographic limitation to Minnesota-based activities.1
• Base Amount: Defined in Subd. 2(c) by reference to IRC Section 41(c). A crucial modification here is that the “average annual gross receipts” and “aggregate gross receipts” used in the federal formula must be recalculated using only Minnesota sales or receipts as defined under section 290.191.1
• Liability for Tax: Subd. 2(d) clarifies that the credit offset is applied against the sum of taxes imposed under sections 290.06, subds. 1 and 2c, reduced by other nonrefundable credits.1 This definition is vital for unitary groups, as it refers to the combined report of the unitary business.1

Qualifying Research Activities: The Technical Threshold

To claim the credit under 290.068, a taxpayer must demonstrate that their activities constitute “Qualified Research.” Both federal law and Minnesota Department of Revenue guidance rely on the “Four-Part Test” to determine eligibility.13 Failure to meet even one of these four criteria results in the disqualification of all associated expenses.13

1. The Technological in Nature Test

The research must fundamentally rely on the principles of the “hard sciences,” such as engineering, physics, biology, or computer science.14 Research related to the social sciences, arts, or humanities is specifically excluded.13 In a business context, this means that developing a new algorithm for a software product or engineering a more durable alloy for a medical device qualifies, but conducting a survey on consumer preferences or designing a new marketing strategy does not.13

2. The Permitted Purpose Test

The objective of the research must be to create a new “business component” or improve the functionality, performance, reliability, or quality of an existing one.13 A business component can be a product, process, software, technique, formula, or invention that the taxpayer intends to hold for sale, lease, or license, or use in its own trade or business.5 Guidance from the Department of Revenue emphasizes that “style, taste, cosmetic, or seasonal design” factors are not permitted purposes.13 For example, changing the color of a mobile phone case is cosmetic, whereas re-engineering the internal circuitry to extend battery life satisfies the permitted purpose test.13

3. The Elimination of Uncertainty Test

Taxpayers must demonstrate that they faced a technical uncertainty at the outset of the project.13 Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the component, or the appropriate design of the component.13 It is important to note that “technical” uncertainty is required, not “economic” uncertainty. A company might be uncertain if a product will sell, but for the credit, they must be uncertain if they can actually build it or how to achieve the desired technical specifications.13

4. The Process of Experimentation Test

Finally, the research must involve a “process of experimentation” designed to identify and evaluate alternatives for achieving the desired result.13 This typically involves the development and testing of a hypothesis, refining or discarding that hypothesis, and conducting systematic trial-and-error.5 Documentation showing the scope of research, project checklists, lab reports, and experiment results is essential here to prove that the work was more than routine engineering or basic troubleshooting.13

Qualified Research Expenses: The Cost Components

The “Qualified Research Expense” (QRE) is the fundamental unit of the credit calculation. Under Statute 290.068, QREs are broken down into four primary buckets, each subject to strict local revenue office guidance regarding documentation and substantiation.13

Taxable Wages for Qualified Services

Wages usually constitute the largest portion of a claim, often accounting for three-quarters of QREs for C corporations in Minnesota.4 These are defined as wages subject to federal income tax withholding and include the portions of an employee’s salary attributable to “qualified services”.11

Qualified services are defined in three tiers:

1. Engaging in Research: The scientists and engineers doing the actual work.10
2. Direct Supervision: The first-line managers who oversee the technical progress of the projects.10
3. Direct Support: Personnel who assist in the research, such as lab assistants who clean equipment or machinists who build prototypes.10

A common “administrative trap” involves the “80% Rule.” If at least 80% of an employee’s services performed during the year constitute qualified services, then 100% of their wages may be included in the QRE calculation.13 This rule simplifies reporting for dedicated research staff but requires rigorous time-tracking for employees who split time between research and commercial production.13

Supplies Used in Research

Supplies include any tangible property—other than land, land improvements, or depreciable property—that is consumed in the research process.13 This often includes materials for prototypes, chemicals for testing, and mockups.11 Supply records must include a list of materials, the location where they were used, and invoices that tie the purchases to a specific qualified project.13 General and administrative supplies, such as office furniture, travel expenses, or telephone costs, are strictly excluded.13

Contract Research Expenses

Many Minnesota firms leverage external expertise from university labs or independent contractors. Under the statute, a taxpayer can claim 65% of the amounts paid to non-employees for qualified research conducted on their behalf in Minnesota.5 This 35% “haircut” is designed to exclude the contractor’s overhead and profit from the state’s subsidy.4 Documentation requirements for contractors are high; the taxpayer must maintain records of the contractor’s scope of work, their physical location (to prove the work was done in Minnesota), and the specific payment agreements.13

Computer Rental and Cloud Hosting Costs

Modern R&D often takes place in virtual environments. Statute 290.068 follows federal law in allowing “amounts paid or incurred for the right to use computers” in the conduct of research.1 This increasingly applies to cloud computing and server hosting costs, provided the computing resources are used primarily (generally >80%) for qualified research activities, such as simulation software or big-data analysis for drug discovery.11

The Base Amount: Calculating the Threshold for Innovation

The “incremental” nature of the Minnesota R&D credit is dictated by the “Base Amount.” This figure represents the level of research a company would “normally” perform as a portion of its business, and only spending above this level qualifies for the credit.8

Historical Base Periods

For established companies, the credit calculation is tied to their performance during the 1984-1988 base period.8 The taxpayer must determine their “Fixed-Base Percentage” by dividing their aggregate Minnesota QREs from 1984-1988 by their aggregate Minnesota gross receipts for that same period.8 This percentage is capped at a maximum of 16%.8

If an older company lacks documentation for its spending in the mid-1980s, they face a difficult hurdle. Historically, this meant they could not calculate a base amount and were thus ineligible for the credit.18 However, legislative proposals have sought to allow these firms to use a default 16% fixed-base percentage to provide an alternative path to eligibility.18

Startup Rules

Companies that were not active during the 1984-1988 period, or that had fewer than three years with both QREs and receipts, are considered “startups” for credit purposes.8 These entities use a fixed-base percentage of 3% for their first five taxable years after 1993 in which they have qualified research expenses.8 For subsequent years, the percentage is determined by a formula based on their actual spending and receipts as they mature.19

The 50% Minimum Base Rule

A crucial “floor” in the calculation is the “Minimum Base Amount” rule found in Subd. 2(c). The statutory base amount can never be less than 50% of the current year’s qualified research expenses.12 This rule has a profound effect on “R&D-heavy” companies whose spending has grown exponentially relative to their historical levels.8 For these taxpayers, the creditable dollars are effectively capped at 50% of their total research budget.8

Calculation Tiers and Theoretical Scenario

To understand how these components interact under Statute 290.068, it is helpful to walk through a mathematical application.

The Tiered Rate Application

The credit provides a distinct advantage for smaller incremental increases. The first $2,000,000 of excess QREs earns a 10% credit ($200,000 maximum for this tier), while any excess above that threshold earns 4%.1

Example: “Lake Superior BioTech”

A Minnesota-based biotechnology firm has the following financials for the 2025 tax year:

• Qualified Research Expenses (Current Year): $6,000,000
• Average Annual Minnesota Gross Receipts (Prior 4 Years): $30,000,000
• Historical Fixed-Base Percentage: 4%

Step 1: Calculate the Preliminary Base Amount.

Using the fixed-base percentage and receipts:

$$Base = 0.04 \times \$30,000,000 = \$1,200,000$$

Step 2: Apply the 50% Minimum Base Rule.

Half of the current year’s QREs:

$$Minimum Base = 0.50 \times \$6,000,000 = \$3,000,000$$

Since $3,000,000 is greater than $1,200,000, the statutory base amount becomes $3,000,000.12

Step 3: Calculate Excess QREs.

$$Excess = \$6,000,000 – \$3,000,000 = \$3,000,000$$

Step 4: Determine the Credit Value.

• First $2,000,000 of excess at 10%: $\$200,000$
• Remaining $1,000,000 of excess at 4%: $\$40,000$
• Total Minnesota R&D Credit: $240,000.1

The 2025 Transformation: Introduction of Partial Refundability

For decades, the inability to monetize credits was the primary complaint of the Minnesota startup community. A nonrefundable credit is of little use to a pre-revenue company that may have millions in R&D costs but zero tax liability.7 The 2025 modification of Statute 290.068 through HF 9 directly addresses this liquidity gap.7

Mechanics of the Refund Election

Beginning with tax years after December 31, 2024, taxpayers can elect to receive a partial refund for current-year credits that exceed their tax liability.11 The refund is calculated by taking the “unused” portion of the current year’s credit and multiplying it by a statutory “refundability rate”.9 Any portion of the credit not refunded is still available to be carried forward for 15 years.9

Phased Refundability Rates

The state has established a schedule of rates that vary by year to balance the goal of providing liquidity with the need for fiscal predictability.9

The 2028 Statewide Refund Target

To prevent an unforeseen drain on the general fund, the 2025 law includes a “Budget Cap” mechanism. Starting in 2028, the Commissioner of Revenue will evaluate the total claims for refunds.10 If the projected total exceeds $25 million annually, the commissioner is required to adjust the refundability rate downward for that year so that the statewide payout approximates $25 million.10 This ensures that while individual taxpayers are not capped, the program’s total fiscal footprint is contained.10

Unitary Business Groups and Combined Reporting

Minnesota’s tax system for corporations is based on the unitary business principle, which assumes that the income of related corporations conducting a single integrated business should be reported together.6 Statute 290.068 includes specific provisions for how the research credit is shared and utilized within these groups.

Allocation of Current-Year Credits

When a member of a unitary group earns an R&D credit, the statute and subsequent revenue office guidance require a specific order of utilization 6:

1. Direct Offset: The credit is first used to offset the tax liability of the member that actually incurred the research expenses.6
2. Group Sharing: If the earning member’s credit exceeds its own tax liability, the excess must be allocated to other members of the unitary group who are included in the combined report.1 This allows the group to reduce the total group tax liability before any credits are carried forward or refunded.6
3. Carryover or Refund: Any credit remaining after the group’s total liability has been reduced to zero is then eligible for the 15-year carryover or the 2025 partial refund.6

The 2020 Carryover Guidance

A major policy shift occurred on June 18, 2020, when the Department of Revenue issued updated online guidance regarding carryover credits.6 Previously, Schedule RD instructions had suggested that a credit carryforward could only be used by the specific member that generated the credit.6 The 2020 update clarified that carryovers must be applied to all other members of a consolidated return in the same manner as current-year credits.6 This significantly increased the utility of the credit for large groups where one entity might be the research hub while other entities generate the majority of the taxable income.25

Pass-Through Entities and Individual Income Tax

For businesses structured as partnerships or S corporations, the credit generated by the entity’s activities in Minnesota flows through to the individual owners.1

S Corporation and Partnership Allocation

• S Corporations: Credits are allocated to shareholders based on their pro-rata share of ownership, following the rules of IRC Section 1366(a).1
• Partnerships: Credits are allocated in the same manner as provided by IRC Section 41(f)(2).1
• Reporting: Individuals claim their share of the credit on their personal Form M1 by attaching Schedule M1C.5 The primary proof of the credit comes from Schedule KS (for S corp shareholders) or Schedule KPI/KPC (for partners).5

The Composite Return Exclusion

A frequent compliance error for out-of-state owners involves composite returns. Many non-resident partners elect to file a composite return to simplify their Minnesota tax obligations.19 However, official guidance and Schedule RD instructions are clear: partners or shareholders electing to file composite returns are not entitled to the research credit.19 To benefit from the credit, these owners must file a formal non-resident Minnesota individual return.6

Compliance and Department of Revenue Guidance

The Minnesota Department of Revenue (DOR) is tasked with enforcing the rigorous technical requirements of Statute 290.068. While the state conforms to many federal standards, the DOR maintains its own administrative priorities and documentation expectations.13

Schedule RD: The Primary Filing Instrument

To claim the credit, businesses must complete Schedule RD, “Credit for Increasing Research Activities”.13 This form requires a detailed breakdown of expenses into wages, supplies, computer rentals, and contract research.19 For 2025, the form has been updated to include Line 37, a specific checkbox for the “Refundable Portion” election, and calculation lines for the refund amount.19

Documentation Standards

The DOR audit division emphasizes that “contemporaneous” records are the gold standard for substantiation.13 Taxpayers should not wait until an audit begins to reconstruct their research claims.3

Specifically, the DOR looks for:

• Activity Logs: Descriptions of the new or improved products or processes, including where the research took place.13
• Wage Breakdown: Names, work titles, and SSNs for every employee in the claim, along with a breakdown of their wages by year and project.13
• Testing Evidence: Documentation of alternatives tested, project authorization records, and lab schedules.13
• The Nexus Proof: Evidence that the research was “actually performed” in Minnesota. Research ordered from a Minnesota office but conducted at a site in another state is strictly excluded.16

Audit Triggers and Third-Party Studies

Claims involving large R&D tax credit studies performed by third-party consulting firms often receive heightened scrutiny.19 Schedule RD now asks if a CPA, attorney, or consultant assisted in the calculation or conducted a study, and if the DOR may discuss the credit directly with those individuals.19 The DOR has historically noted that guidance for taxpayers on documentation is “limited,” leading to complicated disputes during audits regarding what constitutes sufficient evidence of a “process of experimentation”.3

Interaction with Federal Section 174 and Amortization

A major complexity in modern tax planning is how the Minnesota R&D credit interacts with the federal requirement to capitalize and amortize research expenses over five years.8

Decoupling for State Purposes

Under the federal Tax Cuts and Jobs Act (TCJA), businesses can no longer immediately deduct research expenses in the year they are incurred; they must instead spread the deduction over 5 or 15 years.8 In 2023, the Minnesota Legislature passed HF 1938, which effectively “decoupled” the state from this requirement.23 Minnesota Statute now allows taxpayers to subtract the capitalized amount on their state return, permitting the full, immediate expensing of research costs for state income tax purposes.23

Coordination of the Credit and Deduction

While this decoupling is taxpayer-friendly, it requires careful coordination. To prevent a “double benefit,” the statute requires that the amount of the Minnesota R&D credit claimed must be “added back” to Minnesota taxable income if the underlying expenses were also deducted.8 This ensures that while the taxpayer gets the immediate deduction and the credit, they do not get to deduct the portion of the expenses that the state is effectively paying for through the credit.23

Statistical Landscape and Economic Impact

The Research and Development tax credit is one of Minnesota’s most significant tax expenditures. The Department of Revenue’s Tax Expenditure Budget provides a window into the scale and reach of the program.27

Total Expenditure Statistics

The total value of credits claimed has risen sharply as the state’s economy has become more tech-focused.8

Industry Concentration

The manufacturing sector is the dominant force in the R&D credit landscape, accounting for approximately 65% of the total credit value claimed by C corporations.4 Within manufacturing, medical devices (anchored by “Medical Alley”) and computing hardware are primary drivers.7 Other high-growth areas include:

• Agriculture: Strong investments in crop R&D, automation, and food safety.7
• Life Sciences: Institutional research from the Mayo Clinic and corporate R&D from firms like Medtronic and UnitedHealth.7
• Software/SaaS: A thriving scene of software development for both internal use and commercial sale.7

Job and Earnings Growth

A 2017 evaluation by the Office of the Legislative Auditor found that the research tax credit contributed to jobs and earnings growth in Minnesota from 2008 to 2014, although the growth was described as “relatively small”.4 The report noted that while the credit did not “pay for itself” in terms of immediate net fiscal benefits, businesses surveyed indicated that the credit was “moderately important” in helping them hire new employees and retain high-skill positions within the state.4

Proposed but Unenacted: The Alternative Simplified Credit (ASC)

One of the most persistent topics in Minnesota tax policy is the potential adoption of the “Alternative Simplified Credit” (ASC). Under federal law, the ASC allows taxpayers to calculate their credit based on 14% of current-year QREs that exceed 50% of the average QREs from the previous three years.28

The ASC Controversy in Minnesota

Currently, Minnesota Statute 290.068 does not allow the use of the ASC method.13 Taxpayers must use the regular incremental method, which requires historical data back to the 1980s.2

During the 2025 session, several bills (HF 173, SF 1237) were introduced to adopt a Minnesota ASC at a 6% rate.30 Proponents argue that the ASC would:

1. Simplify Compliance: It eliminates the need for 40-year-old records.28
2. Reward Rapid Growth: Companies with fast-growing receipts often find their base amount grows so fast that it wipes out their credit under the regular method. The ASC provides a more accessible hurdle for these firms.28
3. Encourage New Entrants: It incentivizes companies to do research in Minnesota rather than in other states that already offer simplified calculation options.30

While these bills were discussed and estimated to reduce the state’s General Fund by roughly $110 million over a biennium, they have not yet been signed into law as of late 2025.30 Consequently, businesses must continue to navigate the complexities of the regular incremental method and its 1984-1988 base period.13

Nuanced Compliance Traps: Grants and Shared Costs

Navigating 290.068 involves avoiding several subtle “traps” that can lead to disallowed credits upon audit.

The DEED Innovation Grant Exclusion

Minnesota offers various direct funding programs for startups, such as the Innovation Grants from the Department of Employment and Economic Development (DEED).19 Statute 290.068 and Schedule RD instructions are explicit: research expenditures funded by these grants are not eligible for the R&D credit.19 Taxpayers are required to check a specific box on Schedule RD if they received such a grant and must subtract the grant amount from their total QREs to avoid “double-dipping” into state subsidies.19

The “Performed in Minnesota” Rigidity

The DOR applies the geographic restriction of 290.068 with extreme rigidity. If a Minnesota company hires a consultant to perform testing, and that consultant performs the test in a lab in Wisconsin, the expense is disqualified.5 Even if the intellectual property is owned by the Minnesota company and the project is managed from a Minnesota office, the physical act of research must occur within the state lines.13

Computer Rental vs. Capital Equipment

Practitioners must distinguish between the “right to use computers” (qualifying QRE) and the “purchase of computer hardware” (non-qualifying capital expense).11 While cloud server costs for R&D simulations are generally qualifying, the purchase of a high-performance server rack that will be depreciated over several years is considered capital equipment.13 Capital equipment is specifically excluded from the definition of “supplies” for the purpose of the research credit.13

Conclusion: Strategic Outlook for 2025 and Beyond

Minnesota Statutes 290.068 stands as a sophisticated pillar of the state’s business tax code. Its tiered rate structure—offering a generous 10% on initial incremental investments—demonstrates a clear policy preference for nurturing a broad base of smaller innovation projects.1 The historical reliance on a nonrefundable credit limited the statute’s effectiveness for the very startups it aimed to attract, but the 2025 introduction of partial refundability marks a paradigm shift in the state’s economic competitiveness.7

As businesses look forward, the strategic importance of contemporaneous documentation cannot be overstated. With the state now issuing direct refunds, the Department of Revenue is expected to maintain a rigorous audit posture, particularly regarding the “Four-Part Test” and the geographic nexus of the research activities.13 Furthermore, the decoupling from federal Section 174 amortization provides a unique “Minnesota Advantage” that allows for immediate state-level expensing while the federal government continues to require capitalization.23

Ultimately, navigating the meaning of 290.068 requires a dual focus: maximizing the technical claim through a deep understanding of qualifying activities, and ensuring administrative compliance through the complex base amount and unitary allocation rules. For the forward-thinking Minnesota firm, this credit represents more than a tax break; it is a vital source of liquidity and a testament to the state’s commitment to being a global leader in science and technology.

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