The Strategic Evolution of Minnesota’s Research and Development Tax Credit: Navigating Nonrefundability, Partial Refundability, and Compliance Frameworks

A nonrefundable credit is a tax incentive that can reduce a taxpayer’s liability to zero but cannot result in a cash payment for any excess credit beyond that liability. In the context of the Minnesota Research and Development (R&D) tax credit, this mechanism requires businesses to carry forward unused credits to offset taxes in future years rather than receiving an immediate refund.1

The conceptual framework of a nonrefundable credit is rooted in the principle of tax mitigation rather than direct subsidy. For the Minnesota Department of Revenue, the “Credit for Increasing Research Activities,” codified under Minnesota Statute $\S$ 290.068, has historically functioned as a nonrefundable instrument designed to reward profitable companies that reinvest in the state’s innovation economy.1 Unlike a refundable credit, which treats the tax system as a mechanism for distributing grants to businesses regardless of their current tax position, a nonrefundable credit ensures that the state only provides a benefit to those entities currently contributing to the tax base through corporate franchise or individual income taxes.7 This structure serves a dual purpose: it protects the state’s general fund from massive, unpredictable outlays during economic downturns when corporate profits—and thus tax liabilities—drop, while still offering a long-term “deferred tax asset” to companies that are currently in a loss position but expect to be profitable in the future.6 The 15-year carryforward provision is the critical safety valve of this nonrefundable system, allowing a firm that spends millions on R&D today to “bank” those credits for use over the next decade and a half.1 However, the landscape of this credit changed fundamentally with the passage of H.F. 9 in 2025, which introduced a paradigm shift by allowing a specific portion of this traditionally nonrefundable credit to be claimed as a refund, reflecting a modern understanding of the liquidity needs of high-growth technology and life science startups.11

Theoretical and Legal Definition of Nonrefundability in Minnesota

To understand the Minnesota R&D credit, one must first master the distinction between refundable and nonrefundable credits as defined by the Minnesota Department of Revenue (MDOR). According to local revenue office guidance, tax credits are subtracted directly from the tax liability, whereas deductions are subtracted from taxable income before the tax rate is applied.4 A nonrefundable credit can reduce the tax an entity owes to zero, but not below zero. If the credit amount exceeds the tax liability, the taxpayer does not receive the “leftover” amount as a check from the state.2

This mechanism creates a specific economic reality for taxpayers. A company with $\$100,000$ in tax liability and a $\$150,000$ nonrefundable credit will pay $\$0$ in taxes, but the remaining $\$50,000$ provides no immediate cash benefit. Conversely, if that same credit were refundable, the company would pay $\$0$ in taxes and receive a $\$50,000$ check from the state.7 In the specific context of Minnesota Statute $\S$ 290.068, the law explicitly states that for taxable years beginning before January 1, 2025, the credit shall not exceed the “liability for tax”.1 The “liability for tax” is defined as the sum of taxes imposed under section 290.06 (subdivisions 1 and 2c) for the year, reduced by the sum of all other nonrefundable credits allowed under Chapter 290.1 This creates an ordering rule where the R&D credit is often applied after other incentives, further increasing the likelihood that it will exceed the remaining liability and trigger the carryforward provision.14

Comparative Framework of Credit Types in Minnesota

The transition of the R&D credit into the “Partially Refundable” category represents a significant legislative compromise. It acknowledges that while the state cannot afford to make the entire multi-hundred-million-dollar credit program fully refundable, it can provide a “liquidity bridge” for innovative firms by refunding a percentage of the unused portion.11

Statutory Analysis: Minnesota Statute $\S$ 290.068

Minnesota Statute $\S$ 290.068 is the governing law for the Credit for Increasing Research Activities. It is an incremental credit, meaning it does not apply to all research spending, but only to research expenditures that exceed a “base amount”.1 This incremental structure is intended to ensure that the state is not merely subsidizing the “normal” R&D that a company would perform anyway, but is specifically incentivizing increased investment.6

Subdivision 1: The Credit Rate Structure

The credit is calculated using a two-tiered rate system based on the excess of Qualified Research Expenses (QREs) over the base amount. For tax years after December 31, 2016, the rates are as follows:

• Tier 1: $10\%$ of the first $\$2,000,000$ of excess QREs.1
• Tier 2: $4\%$ of any excess QREs above the $\$2,000,000$ threshold.1

The mathematics of the credit are governed by the following formula for the total credit ($C$):

$$C = (0.10 \times \min(E, 2,000,000)) + (0.04 \times \max(0, E – 2,000,000))$$

Where $E$ represents the “Excess QREs,” defined as:

$$E = \text{Current Year QREs} – \text{Base Amount}$$

This tiered structure is designed to be more lucrative for small and mid-sized research projects. A company with $\$2$ million in excess research expenditures receives a $\$200,000$ credit (a $10\%$ effective rate), whereas a massive corporation with $\$100$ million in excess expenditures receives a much lower effective rate because the vast majority of their spending is capped at the $4\%$ level.12

Subdivision 2: Key Definitions and the “Liability for Tax”

The statute defines several critical terms that dictate how the nonrefundable nature of the credit is applied in practice.

• Qualified Research Expenses (QREs): These are defined by incorporating the federal standards found in Section 41(b) and (e) of the Internal Revenue Code (IRC), but with a strict geographical limitation: the research must be conducted within the state of Minnesota.1
• Base Amount: This follows the IRC Section 41(c) definition, but the “average annual gross receipts” must be calculated using only Minnesota sales or receipts as defined under section 290.191.1
• Liability for Tax: This is the “ceiling” for the nonrefundable credit. It is the taxpayer’s tax liability after all other nonrefundable credits have been applied.1 This means if a taxpayer has a “Marriage Credit” or “Long-Term Care Credit,” those must be used first. If those credits reduce the tax to zero, the R&D credit cannot be used in the current year and becomes a $100\%$ carryforward.14

Subdivision 3: Limitation and Carryover Mechanics

The statute provides that the credit for a taxable year shall not exceed the liability for tax.1 However, any amount exceeding this limit is not lost. The “excess” credit can be carried forward to each of the 15 succeeding taxable years.1 The law requires that the oldest carryforwards be used first (the “First-In, First-Out” or FIFO method) to ensure that credits do not expire unnecessarily.1

There is also a “50-percent limit” mentioned in legislative analysis: the credit cannot exceed $50\%$ of the business’s total research expenditures for the year.6 This typically affects large, multi-state businesses whose Minnesota base amounts are low due to low state-level gross receipts, but who conduct significant R&D in the state.6

The 2025 Legislative Pivot: H.F. 9 and the Refundable Election

For decades, the Minnesota R&D credit was strictly nonrefundable. This changed on June 14, 2025, when Governor Tim Walz signed H.F. 9, which introduced “partial refundability” for tax years beginning after December 31, 2024.10 This is perhaps the most significant update to Statute $\S$ 290.068 in the modern era, as it allows non-profitable startups to monetize their credits immediately.11

The Mechanics of the Refundable Election

Under the new Subdivision 3a, a taxpayer can make an “irrevocable election” to receive a partial refund of their unused R&D credits.10 This is not a full refund. Instead, a “refundability rate” is applied to the excess credit that remains after the taxpayer’s liability has been reduced to zero.10

The state has established a tiered schedule for these refundability rates:

The rationale for the $19.2\%$ rate in the first year is largely fiscal. State budget analysts use these rates to control the “burn rate” of the general fund.12 Starting in 2028, the Commissioner of Revenue is required to adjust the refundability rate annually by December 15, based on November revenue forecasts, with the goal of keeping the total statewide R&D refund payout at or below $\$25,000,000$ per year.11

Procedural Requirements for the Election

The Minnesota Department of Revenue is extremely precise about how this election must be made.

1. Timing: The election must be made on a “timely filed return,” which includes the automatic seven-month extension period.1
2. Irrevocability: Once the election is made for a specific tax year, it cannot be changed. A taxpayer cannot file an amended return later to “undo” the refund and switch back to a full carryforward.10
3. Application Order: The refundable portion is calculated after the tax liability has been reduced to $\$0$ by all other credits and the current year R&D credit.14
4. Carryforward Impact: If a taxpayer elects the refund, the portion of the credit that was not refunded (e.g., the other $80.8\%$ in 2025) remains available to be carried forward for the standard 15 years.11

Local State Revenue Office Guidance: Compliance and Documentation

The Minnesota Department of Revenue (MDOR) provides detailed guidance via Fact Sheets and Schedule RD Instructions to ensure taxpayers comply with the rigorous “Four-Part Test” derived from IRC $\S$ 41.12 Because the R&D credit is one of the most frequently audited items in the corporate tax world, the MDOR emphasizes that “contemporaneous documentation” is the only defense against a credit being disallowed.14

The Four-Part Test in a Minnesota Context

Every dollar claimed as a Qualified Research Expense must satisfy all four prongs of this test:

• Permitted Purpose: The activity must relate to a new or improved function, performance, reliability, or quality of a business component.9
• Elimination of Uncertainty: The taxpayer must intend to discover information that eliminates technical uncertainty regarding the capability, method, or design of the component.14
• Process of Experimentation: The taxpayer must evaluate one or more alternatives through a systematic process, such as modeling, simulation, or trial-and-error.14
• Technological in Nature: The process must fundamentally rely on the principles of physical or biological sciences, engineering, or computer science.9

MDOR Record-Keeping Requirements

The revenue office mandates that taxpayers maintain specific records for each category of expense. Failure to provide these upon request can lead to an immediate denial of the credit.14

The MDOR explicitly warns that certain costs do not qualify, including research conducted outside of Minnesota, market research, routine quality control, social science research, and research conducted after commercial production has begun.14

Detailed Example: Calculating the 2025 Credit with the Refundable Election

To demonstrate the intersection of the nonrefundable tradition and the new refundable election, consider the case of “NorthStar Biotech,” a Minnesota corporation engaged in developing a new medical diagnostic tool.

Scenario Assumptions

• 2025 Minnesota QREs: $\$2,500,000$ (Wages for researchers, lab supplies, and contract testing).
• Base Amount: $\$500,000$ (Based on previous years’ MN receipts and R&D spending).
• Excess QREs: $\$2,000,000$ (Calculated as $\$2,500,000 – \$500,000$).
• 2025 Tax Liability: $\$40,000$ (Tax owed to Minnesota before the R&D credit).

Phase 1: Calculating the Gross Credit

Applying the tiered rates from Statute $\S$ 290.068:

1. Tier 1 ($10\%$ of first $$2M excess): $0.10 \times \$2,000,000 = \$200,000$.1
2. Tier 2 ($4\%$ of excess over $$2M): $0.04 \times \$0 = \$0$ (Since excess is exactly $\$2M$).
3. Total Credit Generated: $\$200,000$.

Phase 2: Application Against Tax Liability (The Nonrefundable Part)

The credit is first applied to the taxpayer’s $\$40,000$ liability.

• Tax Liability: $\$40,000$
• Credit Applied: $\$40,000$
• Remaining Tax Due: $\$0$.
• Unused Credit (Excess): $\$160,000$ (Calculated as $\$200,000 – \$40,000$).

Phase 3: The 2025 Refundable Election (The Modern Twist)

NorthStar Biotech elects the $19.2\%$ partial refund for the 2025 tax year.1

• Refundable Portion: $\$160,000 \times 0.192 = \$30,720$.
• Cash Refund Check: $\$30,720$ (Issued by the MDOR).
• Carryforward Remaining: $\$160,000 – \$30,720 = \$129,280$.

In this example, the company uses the credit as a nonrefundable tool to wipe out their tax bill completely and then exercises the new legislative option to turn a portion of the “useless” excess into $\$30,720$ of immediate working capital. The remaining $\$129,280$ stays on their books as a carryforward for up to 15 years to offset future taxes.10

Unitary Groups and Flow-Through Entity Considerations

Minnesota law provides specific rules for how “Unitary Business Groups”—corporations under common control that form a single economic unit—and “Flow-Through Entities” like S-corps and Partnerships handle the R&D credit.1

Unitary Group Allocation

In a unitary group, the member that actually incurred the research expenses (the “earning member”) must use the credit against its own tax liability first.14 If the earning member has a surplus credit, Statute $\S$ 290.068 allows them to allocate that excess to other members of the unitary group who have a tax liability.1 This is a powerful tax planning tool that allows a research-intensive subsidiary to offset the tax bill of a profitable sales subsidiary within the same group.1

However, there is a catch: if the credit becomes a carryforward (it isn’t used by anyone in the year it was generated), it stays with the earning member. In future years, the earning member must use the carryforward against its own tax liability first before it can be allocated to other group members again.19

Flow-Through Entities (S-Corps, Partnerships, LLCs)

The R&D credit is generated at the entity level but is “passed through” to the individual partners or shareholders on a pro-rata basis.6

• Reporting: The entity files Schedule RD and provides each owner with a Schedule KPI or KS showing their share of the credit.15
• Limitations: For partners, the credit is limited to the tax attributable to their share of the partnership’s income.15
• Refund Election: In a crucial detail of MDOR guidance, for tax years starting in 2025, the election for the partial refund is made by the partners, members, or shareholders on their individual returns, not by the partnership itself.14

Interplay with the Alternative Minimum Tax (AMT)

The interaction between the R&D tax credit and the Alternative Minimum Tax (AMT) is a common source of confusion for taxpayers. Minnesota imposes a $6.75\%$ AMT on individuals, estates, and trusts to ensure they pay a minimum level of tax regardless of how many credits they claim.22

Historically, R&D credits could only offset the “regular tax.” If the regular tax fell below the AMT threshold, the credit provided no benefit.24 Under federal law (the PATH Act), small businesses with less than $\$50$ million in gross receipts can now use R&D credits to offset federal AMT.24 However, Minnesota’s treatment remains stricter. While the R&D credit reduces the regular tax, it generally does not directly reduce the Minnesota AMT liability for individuals.23

A taxpayer who pays Minnesota AMT in a given year may be entitled to an “Alternative Minimum Tax Credit” in a future year when they no longer owe AMT.23 This is a separate, nonrefundable credit that is reported on Schedule M1MTC and eventually flows to the main Schedule M1C.26

Statistical Context: The Rising Cost of Innovation in Minnesota

Data from the Minnesota House Research Department and the Department of Revenue’s Tax Expenditure Budget reveals that the Credit for Increasing Research Activities has become one of the state’s most significant corporate incentives.6

Historical and Projected Tax Expenditure for the R&D Credit

The massive spike in cost starting in Fiscal Year 2024 is largely attributed to the growth in corporate franchise tax liability and a rebound in post-pandemic R&D spending.6 Furthermore, the federal requirement to amortize R&D expenses (Section 174) instead of deducting them immediately has increased the state taxable income of many Minnesota corporations, thereby allowing them to “use” more of their nonrefundable R&D credits in the current year rather than carrying them forward.6

Strategic Implications and Audit Readiness

For business leaders, the Minnesota R&D credit is no longer a “set it and forget it” item on a tax return. The shift to partial refundability makes it a critical component of annual cash flow planning.10

To Refund or Not to Refund?

Companies must conduct a quantitative analysis to decide if they should elect the refund:

• The Startup Perspective: For a company burning cash and years away from profitability, the $19.2\%$ refund in 2025 is often a “no-brainer.” It provides immediate cash that can be used to hire another engineer or buy a piece of lab equipment today.10
• The Profitable Entity Perspective: If a company is currently in a loss but expects to be highly profitable in 2026, they may choose not to elect the refund. By forgoing the $19.2\%$ cash payment today, they preserve $100\%$ of the credit value as a carryforward, which will offset taxes dollar-for-dollar (a $100\%$ “refund” in effect) just one year later.10

The Audit Landscape

Because the R&D credit represents a direct reduction of tax (and now a potential cash payout), the MDOR subjects these claims to high scrutiny.14 Common audit triggers include:

• Sudden Spikes in QREs: A dramatic increase in research spending compared to previous years often warrants an inquiry into whether the “incremental” nature of the credit is being manipulated.6
• Inadequate Time Tracking: “Estimates” of R&D time are generally not sufficient for the MDOR. They prefer contemporaneously maintained logs that show exactly which projects an employee worked on during specific pay periods.14
• Innovation Grant Funding: If a company receives an “Innovation Grant” from the Department of Employment and Economic Development (DEED), expenses funded by that grant are not eligible QREs. Taxpayers often forget to subtract these amounts, leading to audit adjustments.14

Conclusion: A New Era for Minnesota Innovation

The Minnesota Credit for Increasing Research Activities has transitioned from a stable, nonrefundable incentive for established corporations into a flexible, dual-track tool for all stages of a company’s lifecycle.1 By maintaining the 15-year carryforward for those who prioritize long-term tax reduction and introducing a partial refund option for those who need immediate liquidity, the state has positioned itself as a competitive environment for R&D.8

However, this increased flexibility comes with a higher compliance burden. The irrevocable nature of the 2025 refund election, the strict 50% expenditure limit, the complexities of unitary group allocation, and the ever-present threat of a MDOR audit mean that businesses must integrate tax planning into their core R&D strategy.9 As the state moves toward a $\$25$ million cap on refunds in 2028, the “early mover” advantage of claiming and electing these refunds now, while the rates are fixed at $19.2\%$ and $25\%$, cannot be overstated.1 For the professional peer group of tax directors and CFOs, the message from the Minnesota revenue office is clear: innovation is rewarded, but only if it is meticulously documented and strategically claimed within the shifting boundaries of the law.14

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