The Minnesota R&D Tax Credit: A Comprehensive Analysis of the Refundable Portion and Fiscal Implementation

The refundable portion of the Minnesota Credit for Increasing Research Activities constitutes a statutory mechanism allowing eligible taxpayers to receive a cash payment for a specific percentage of their unused current-year research credits. This provision enables businesses to monetize credits that exceed their state tax liability, providing immediate liquidity as an alternative to the traditional fifteen-year carryforward period.1

The landscape of innovation incentives in the State of Minnesota underwent a fundamental shift with the passage of the 2025 omnibus tax legislation. This legislative action, codified primarily through House File 9 (H.F. 9), reintroduced a partial refundability feature to the state’s Research and Development (R&D) tax credit framework for the first time since the post-recession stimulus period of 2010 to 2012.2 Under the revised Minnesota Statutes Section 290.068, the credit remains an incremental incentive designed to reward businesses that increase their investment in qualified research within the state’s borders.6 However, the introduction of the refundable option addresses a long-standing criticism of non-refundable credits: that they offer little to no utility for early-stage startups or research-intensive firms that have not yet achieved profitability or generated sufficient tax liability to offset their credits.1 By providing a pathway to immediate cash infusion, Minnesota aligns its fiscal policy with other innovation-driven states, seeking to retain domestic technology firms and attract global manufacturers in high-growth sectors such as medical devices, agriculture, and software development.8

Legislative Evolution and Statutory Framework

The Minnesota Credit for Increasing Research Activities was originally established by the 1981 Legislature, largely mirroring the federal research credit introduced by the United States Congress in the same year.9 Throughout its history, the credit has transitioned between non-refundable and refundable statuses, reflecting the changing economic priorities of successive state administrations. For the vast majority of its existence, the credit was non-refundable and could only be used to offset corporate franchise tax.7 In 2010, as part of a temporary economic stimulus, the credit was made refundable and extended to pass-through entities, including partnerships and S corporations.5 This temporary window closed in 2013, returning the credit to a strictly non-refundable carryforward structure until the enactment of H.F. 9 in June 2025.2

The current statutory authority, Minnesota Statute Section 290.068, defines the “Credit Allowed” as a tiered percentage of the excess of qualified research expenses over a base amount.5 The legal definitions within the statute are of paramount importance for any entity seeking the refundable portion, as they establish the baseline for eligibility.

Statutory Definitions and Tiered Rates

The credit calculation is bifurcated into two distinct tiers based on the volume of qualified research conducted. The law provides for a more generous credit on initial research investments to support smaller and mid-sized enterprises while scaling back the percentage for larger expenditures to manage the state’s total fiscal exposure.1

The “excess” is defined as the amount by which qualified research expenses for the taxable year exceed a “base amount”.6 Minnesota defines “qualified research expenses” (QREs) and “qualified research” by reference to Section 41 of the Internal Revenue Code (IRC), with the critical caveat that the research must be conducted within the state of Minnesota.3 The “base amount” calculation is similarly tied to IRC Section 41(c), but it must be computed using Minnesota-specific sales or receipts and Minnesota-specific research spending.3

The Mechanics of Partial Refundability under H.F. 9

The enactment of H.F. 9 (Chapter 13) on June 14, 2025, introduced the elective “refundable portion” for taxable years beginning after December 31, 2024.2 This new provision does not make the entire credit refundable; rather, it allows a taxpayer to elect to receive a cash refund for a specific percentage of the credit that remains after their tax liability has been reduced to zero.3

The Refundability Rate Schedule

The legislature established a transition period with varying refundability rates to phase in the program’s fiscal impact. These rates are applied to the portion of the credit that exceeds the tax liability for the year.1

Starting in tax year 2028, the Commissioner of Revenue is empowered to adjust the refundability rate annually. The statute mandates that the rate be set such that the total projected refunds across the entire state do not exceed approximately $25,000,000.1 The Department of Revenue must determine this rate by December 15 of the year preceding the tax year and publish it on its website.1 This mechanism serves as a fiscal “circuit breaker,” ensuring that a surge in research activity does not create an unmanageable drain on the state’s general fund.1

The Election Process and Irrevocability

The refundable portion is not an automatic payment. Taxpayers must proactively elect to receive the refund on a timely filed return, including any extensions granted by the state.3 Once a taxpayer makes the election for a specific tax year, it is irrevocable.2 This means that a business cannot later decide that a carryforward would have been more advantageous and amend their return to reverse the refund.1

For unitary business groups, the election process involves additional layers of coordination. The credit must first be applied against the tax liability of the member that earned the credit. Any remaining credit must then be shared with other members of the unitary group to reduce their liabilities before the refundable portion can be calculated.5 Only the residual credit, after exhausting the group’s collective tax liability, is eligible for the refundability rate.3

Minnesota Department of Revenue Guidance: Schedule RD

The Minnesota Department of Revenue (MDOR) provides the primary administrative guidance for calculating the refundable portion through the instructions for Schedule RD, “Credit for Increasing Research Activities.” The calculation sequence is critical to ensuring compliance with the law and maximizing the benefit.3

Calculating the Refundable Amount on Schedule RD

The 2025 iteration of Schedule RD includes specific lines for the refundability calculation. The process follows a logical progression of applying the credit to current liabilities before determining the excess eligible for refund.16

• Line 31 (Tentative Credit): This line captures the sum of the current year credit generated by the taxpayer and any share of credit passed through from a partnership or S corporation.16
• Line 32 (Limitation): The credit is limited by the taxpayer’s liability for tax, which is calculated after other non-refundable credits have been applied.6
• Line 34 (Unitary Allocation): For companies filing a combined return, the excess credit must be allocated to other members of the unitary group.5
• Line 36 (Remaining Credit): This represents the current year credit that exceeds the total liability of the unitary group.16
• The Refundable Election Box: Taxpayers must check a specific box located between lines 37 and 38 to signal their election of the refundable portion.3
• Line 37 (Refundable Credit Amount): If the election box is checked, the taxpayer multiplies the amount from Line 36 by the applicable rate (19.2% for 2025).16
• Line 38 (Non-refundable Remainder): The remaining balance (the 80.8% of excess that was not refunded in 2025) is calculated here and becomes eligible for the fifteen-year carryforward.16

Interaction with Carryovers

A point of frequent confusion involves the interaction between the new refundable portion and historical carryovers. The MDOR guidance clarifies that the refundable election applies strictly to the current year credit.3 Previous year carryovers are applied to the tax liability after non-refundable credits but are not eligible for the cash refund under the H.F. 9 provisions.11 This prioritizing ensures that taxpayers use their oldest, non-refundable credits first to offset liability, while preserving the liquidity potential of the newly generated current-year credits.5

Core Eligibility: Qualified Research Activities (QRA)

The legitimacy of a claim for a refundable R&D credit rests entirely on the definition of Qualified Research Activities (QRA). Minnesota adheres to the federal “Four-Part Test” established under IRC Section 41(d), but the application is geographically restricted to Minnesota.3

The Four-Part Test Application

To qualify for the Minnesota credit, and thus the refundable portion, an activity must satisfy all four of the following criteria:

1. Permitted Purpose: The research must be related to developing a new or improved business component’s function, performance, reliability, or quality.3
2. Elimination of Uncertainty: The activity must be intended to discover information to eliminate technical uncertainty regarding the capability, method, or design for developing or improving a product or process.3
3. Process of Experimentation: The taxpayer must engage in a systematic process of evaluating alternatives, which may involve modeling, simulation, or systematic trial and error.3
4. Technological in Nature: The research must fundamentally rely on the principles of physical science, biological science, engineering, or computer science.1

The MDOR specifically excludes activities such as style or cosmetic design, routine quality control, or the adaptation of existing business components.3 Furthermore, research must be conducted in Minnesota; if wages are paid to an employee for research conducted at a facility in Wisconsin, those wages are ineligible for the Minnesota credit, even if the company is headquartered in Minneapolis.3

Identifying Qualified Research Expenses (QRE)

Expenses eligible for the credit and its refundable portion are categorized into direct and indirect costs associated with the QRA.

The 2025 legislation also preserves the inclusion of contributions to certain nonprofit organizations for basic research, which can be an important factor for philanthropic corporations supporting the state’s academic institutions.1

Detailed Example: Calculating the Refundable Portion

To illustrate the application of these rules, consider “AgroTech Dynamics,” a C corporation based in Minnesota that develops automated soil sensor technology. For the 2025 tax year, AgroTech Dynamics reports the following:

• Total Minnesota QREs: $3,500,000
• Base Amount: $1,500,000 (calculated as 50% of current QREs due to startup status).1
• Excess QREs: $3,500,000 – $1,500,000 = $2,000,000.
• 2025 Minnesota Tax Liability: $15,000.

Step 1: Calculate the Tentative Credit

Using the tiered rates of 10% on the first $2,000,000 of excess:

$$Credit = \$2,000,000 \times 0.10 = \$200,000$$

.1

Step 2: Exhaust the Tax Liability

The credit is first used to reduce the $15,000 tax liability to zero.

• Used Credit: $15,000.
• Excess Unused Credit: $200,000 – $15,000 = $185,000.16

Step 3: Elect and Calculate the Refundable Portion

AgroTech Dynamics elects to receive the 19.2% refund for the 2025 tax year.

$$Refundable Amount = \$185,000 \times 0.192 = \$35,520$$

.1

Step 4: Determine the Carryforward

The remaining portion of the excess credit is carried forward to the 2026 tax year.

$$Carryforward = \$185,000 – \$35,520 = \$149,480$$

.16

In this scenario, AgroTech Dynamics receives an immediate cash benefit of $35,520 and eliminates a $15,000 tax bill, providing total liquidity of $50,520 in the current year, despite having low taxable income.1

Unitary Business Groups and Combined Reporting

A significant portion of R&D in Minnesota is conducted by large, multi-entity corporate groups. The law governing the refundable portion of the R&D credit must be viewed through the lens of Minnesota’s unitary business reporting requirements.

Sharing and Allocation of the Credit

Minnesota Statute Section 290.068, Subdivision 3, mandates that the R&D credit be shared among members of a unitary group. The earning member must first apply the credit against its own liability.5 If an excess remains, that excess must be allocated as a research credit to another member of the unitary group that has liability.5 This rule is designed to ensure that the credit is fully utilized to offset the state’s tax revenue before any cash refund is issued.5

Guidance issued by the MDOR in 2020 clarified that R&D credit carryovers must also be shared among other members of the combined group, similar to the treatment of current-year credits.5 This prevents a situation where one member of a group receives a cash refund while another member of the same group pays significant taxes. The refundable portion is essentially the “last resort” for a credit that cannot be absorbed by any member of the combined group.5

The Role of the Designated Filer

In a unitary group, the designated filer is responsible for completing Schedule RD and making the election for the refundable portion. Because the election is irrevocable and impacts the long-term carryforward pool of the entire group, the decision to claim a refund requires a centralized financial analysis of the group’s projected tax liabilities over the next fifteen years.4

Pass-Through Entities and Individual Shareholders

For partnerships, LLCs, and S corporations, the R&D credit flows through to the individual owners, but the mechanic for claiming the refundable portion follows a distinct path.

Allocation to Partners and Shareholders

The credit generated at the entity level is allocated to partners or shareholders in the same manner as other items of income or loss (pro-rata based on ownership).1 For partnerships, this follows IRC Section 41(f)(2), and for S corporations, it follows IRC Section 1366(a).5 Owners receive their share of the credit on Minnesota Schedule KPI (for partners) or Schedule KS (for shareholders).5

The Individual Refund Election

The election to receive the refundable portion is made by the individual partner or shareholder on their own Form M1.3 This allows for flexibility within a partnership; for example, a high-income partner may choose to use the credit as a non-refundable offset against their personal tax liability, while a partner with lower income may elect to receive the 19.2% cash refund for the unused portion of their allocated credit.5

The law imposes specific limits on the refundable portion for partners. The refund cannot exceed the individual’s proportionate share of the partnership’s total tax liability, effectively preventing individuals from using the R&D credit to generate a refund that is disproportionate to their investment in the research-performing entity.8

Fiscal and Economic Context of the R&D Credit

The reintroduction of refundability in 2025 is a response to the perceived underperformance of the credit during its strictly non-refundable years. An evaluation by the Office of the Legislative Auditor found that while the R&D credit has generated jobs and earnings growth, the growth was relatively small compared to the total cost of the credit.9

Statistics on Credit Utilization and Cost

The cost of the Minnesota R&D tax credit has risen steadily over the last decade, reflecting both inflation and increased investment in high-tech sectors.

Historically, manufacturing has been the primary beneficiary of the credit, claiming approximately 65% of the total.9 However, the 2025 changes are specifically aimed at diversifying the recipient base toward early-stage technology and life science companies that currently lack the profits to utilize non-refundable credits.1

The $25 Million Refund Target Rationale

The decision to cap total statewide refunds at $25 million per year starting in 2028 is a strategic choice to balance the goal of stimulating innovation with the need for budgetary predictability.1 By allowing the refundability rate to float, the state avoids the need for complex per-taxpayer caps or “first-come, first-served” applications that could disadvantage smaller firms.1 This approach ensures that all eligible taxpayers receive a proportionate share of the available refund pool, even if the individual percentages are reduced in high-growth years.1

Compliance, Documentation, and Audit Readiness

The introduction of the refundable portion increases the stakes for documentation and compliance. Because the credit now results in direct cash payments from the state treasury, the MDOR is expected to increase its scrutiny of claims to ensure they meet the rigorous definition of “Qualified Research”.

Mandatory Recordkeeping Requirements

The Department of Revenue emphasizes that the burden of proof rests entirely with the taxpayer. Failure to provide contemporaneous documentation can result in the full denial of the credit and the subsequent recapture of any issued refunds, often with significant penalties and interest.1

Key documentation requirements include:

• Employee-Level Substantiation: Records must identify every individual involved in the research, their location, the specific projects they worked on, and the percentage of their time dedicated to qualified activities.3
• Technical Documentation: Businesses must maintain records of the uncertainties they were trying to solve and the process of experimentation they used. This often includes laboratory notebooks, prototype designs, testing logs, and software development sprint histories.1
• Supply Tracking: Invoices and inventory records must prove that supplies were used for R&D purposes and not for general production or administrative use.3
• Federal Conformity Records: The MDOR may request copies of the federal Form 6765 and any signed certification statements filed with the IRS to ensure that the Minnesota claim is consistent with federal reporting.3

The Risk of Recapture and Penalties

If a taxpayer elects the refundable portion and is later audited, the MDOR has the authority to assess additional tax if the research is found to be non-qualified. For credits that were refunded, this means the taxpayer must pay back the 19.2% (or 25%) cash benefit plus the standard 5% late filing or unpaid tax penalties if the adjustment occurs after the filing deadline.19 The statute of limitations for these assessments is generally three and a half years from the date the return was filed.1

Strategic Planning: Refund vs. Carryforward

The choice between a cash refund and a carryforward is a classic capital allocation problem. For a professional tax practitioner, the decision involves calculating the Net Present Value (NPV) of each option based on the company’s internal rate of return and projected profitability.2

Financial Analysis of the Election

In 2025, a taxpayer electing the refund receives 19.2 cents for every dollar of excess credit. If they choose the carryforward, they retain the full dollar of credit to offset future taxes.1

• When to Elect the Refund: This option is generally superior for startups with no clear path to profitability within the next ten years, or for businesses facing immediate liquidity constraints where the 19.2% cash infusion has a higher utility than a 100% future tax offset.1
• When to Choose the Carryforward: Profitable businesses that expect to have significant Minnesota tax liability in the next two to four years should typically avoid the refund election. The 100% value of the credit realized within a few years is almost always higher than the 19.2% or 25% discounted cash value today.2

Furthermore, the 2017 federal Tax Cuts and Jobs Act (TCJA) significantly changed the treatment of research expenditures under Section 174, requiring them to be amortized over five years rather than expensed immediately.7 This change has increased the federal and state tax liability for many research-heavy firms, potentially making the R&D credit carryforward more valuable than it was in previous years.7

Administrative and Procedural Guidelines

For the 2025 tax year, the MDOR has streamlined the filing process to accommodate the new refundable election. Taxpayers should ensure they use the correct forms to avoid processing delays or the loss of their refund eligibility.

Filing Requirements for Corporations and Pass-Throughs

Corporations must file Form M4 and include Schedule RD. The refundable amount from Schedule RD, Line 37, is carried over to Form M4, Line 7, where it is treated as a payment against the total tax due.15 If the payments (including the refundable R&D credit) exceed the tax due, the taxpayer receives a refund.15

Pass-through entities file Form M3 (for partnerships) or Form M8 (for S corporations). These entities do not claim the refund themselves but provide the necessary data to their owners on Schedules KPI or KS.5 The individual owners then report the credit on Schedule M1C and make their refund election on their Form M1.5

Extensions and Payment Deadlines

It is important to note that while all corporations are granted an automatic seven-month extension to file their return, this is not an extension to pay.15 Any tax liability must be paid by the regular due date (typically the 15th day of the fourth month after the close of the tax year).15 If a taxpayer anticipates a significant refundable R&D credit, they may be able to reduce their estimated tax payments throughout the year, but they must do so cautiously to avoid underpayment penalties.19

The Future of the Refundable Portion: 2028 and Beyond

As the Minnesota R&D tax credit moves toward its new steady state, the $25 million statewide cap will become the primary focus of tax planners. The volatility of the refundability rate after 2027 introduces a layer of complexity for multi-year research projects.1

A business starting a major five-year research project in 2025 may calculate its return on investment based on a 25% refund rate in 2026 and 2027. However, if the program becomes highly successful and total claims surge by 2028, that rate could drop to 15% or 10%.1 This “proration risk” means that the R&D credit remains a valuable incentive, but its cash-out value is not a fixed guarantee for the long term.1

Conclusion

The introduction of the “Refundable Portion” of the Minnesota R&D tax credit marks a strategic pivoting of state fiscal policy toward the support of high-growth, innovative enterprises that are not yet profitable. By providing a pathway for immediate cash infusion—19.2% for tax year 2025 and 25% for 2026 and 2027—Minnesota has addressed a critical gap in its incentive framework. While the election to receive a refund is irrevocable and requires the forfeiture of the remaining credit value, it provides a vital lifeline for startups and a powerful tool for corporate liquidity management.

Success in navigating this new landscape requires a deep understanding of the statutory definitions under Section 290.068, the meticulous line-by-line requirements of Schedule RD, and the complex allocation rules for unitary groups and pass-through entities. As the state moves toward a capped refund model in 2028, the importance of contemporaneous recordkeeping and proactive tax planning will only increase. For professional peers in the tax and financial sectors, the refundable R&D credit is no longer just a deferred tax asset, but a dynamic component of corporate finance that demands sophisticated, NPV-driven decision-making.

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