Comprehensive Analysis of Minnesota Schedule KPI and the Credit for Increasing Research Activities

Schedule KPI is a supplemental tax schedule provided by partnerships to their individual, estate, or trust partners to report their distributive share of Minnesota-specific income, credits, and modifications. Within the specific context of the Minnesota Research and Development tax credit, Schedule KPI acts as the primary jurisdictional mechanism for passing the “Credit for Increasing Research Activities” from the partnership entity to the partner for use on their individual income tax return.1

The administrative and legal architecture of the Minnesota tax system relies heavily on the transparency provided by Schedule KPI to ensure that tax incentives intended to stimulate the state’s economy are accurately claimed at the individual level.1 Because a partnership is treated as a pass-through entity for tax purposes, it does not pay the primary income or franchise tax itself; rather, it calculates the total credit generated by its activities and then allocates that credit to its partners based on their specific ownership interests.4 This allocation is strictly governed by both Minnesota Statutes and the Internal Revenue Code, requiring precise reporting on Line 26 of the 2025 Schedule KPI to avoid disallowance of the credit by the Minnesota Department of Revenue.4 The schedule does more than report a simple number; it serves as a bridge between the entity-level research activities conducted within Minnesota borders and the individual’s tax liability, ensuring that the credit is only applied against Minnesota-sourced income or tax obligations.1

The Historical and Policy Evolution of the Minnesota Research Credit

The Minnesota Credit for Increasing Research Activities, colloquially known as the R&D credit, was established by the Minnesota Legislature in 1981.8 Its primary policy objective was to pattern a state-level incentive after the federal research credit introduced the same year, thereby encouraging businesses to locate and expand their high-technology and scientific research operations within Minnesota.8 For over four decades, the credit has undergone numerous legislative revisions, shifting between refundable and nonrefundable status as the state’s economic priorities and fiscal health fluctuated.

Between 2010 and 2012, the credit was made fully refundable as a temporary measure to stimulate the economy following the Great Recession.10 During this period, businesses that lacked sufficient tax liability to utilize the credit could receive the full value as a cash refund from the state treasury.10 However, in 2013, the legislature returned the credit to a nonrefundable status, allowing only for a 15-year carryforward of unused amounts.9 This nonrefundable status remained the norm until the 2025 legislative session, when Governor Tim Walz signed H.F. 9 into law, reintroducing a partial refundability option starting for tax years beginning after December 31, 2024.12 This latest pivot reflects a contemporary focus on supporting early-stage, cash-strapped technology startups that may be years away from profitability but are conducting the very research the state seeks to incentivize.14

The economic impact of the credit is significant, with total state expenditures for the incentive reaching an estimated $150 million by fiscal year 2025.9 Data from the 2024 Tax Expenditure Budget indicates that while the majority of the credit value is claimed by C-corporations, a substantial and growing portion—roughly $34.8 million in 2025—is claimed by individuals via pass-through entities such as partnerships and S-corporations.8

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Statutory Framework: Minnesota Statute 290.068

The legal authority for the credit is codified in Minnesota Statute Section 290.068, which defines the eligibility criteria, calculation methods, and limitations of the incentive.11 The statute explicitly links the state credit to Section 41 of the Internal Revenue Code (IRC), adopting federal definitions for qualified research and qualified research expenses, with several critical state-specific modifications.16

The Geographical Requirement

Perhaps the most important deviation from the federal IRC is the “Minnesota-only” requirement. Under Section 290.068, Subdivision 2, qualified research does not include any research conducted outside the state of Minnesota.16 For partnerships operating in multiple states, this necessitates a rigorous accounting of where research personnel are physically located when performing their duties. If a partnership employs a researcher who works from a home office in Wisconsin or at a branch in California, the wages paid for that time are ineligible for the Minnesota credit, even if they qualify for the federal credit.7

The Tiered Rate Structure

Minnesota employs a tiered calculation for the credit that provides a higher incentive for the first several million dollars of research spending. This is designed to benefit small and mid-sized businesses more proportionally than the federal regular credit method might.9

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The “excess” research expenses are defined as the amount by which the current year’s qualified research expenses (QREs) exceed a calculated “base amount”.14 This incremental nature ensures that the credit rewards businesses for increasing their research efforts over time, rather than simply maintaining a baseline level of activity.9

The Schedule KPI Instrument: Line-by-Line Mechanics

For a partner in a Minnesota partnership, Schedule KPI is the document that translates the entity’s research activities into a usable tax asset. The form is updated annually by the Minnesota Department of Revenue to reflect legislative changes and new reporting requirements.2

Historical and Current Line References

The location of the R&D credit on Schedule KPI has changed in recent years to accommodate new credits and modifications.

• 2022 and 2024 Schedules: The Credit for Increasing Research Activities was typically reported on Line 24.1
• 2025 Schedule: The credit has been moved to Line 26.4

This shift is partly due to the inclusion of new line items, such as Line 16 for disallowed Section 280E expenses of licensed cannabis or hemp businesses, and Line 21 for pro rata shares of net gains relating to dispositions of Class 2a property.2 Tax professionals must ensure they are referencing the correct line for the specific tax year being filed, as misreporting can lead to processing delays or automated adjustment notices from the state.2

Interaction with Resident and Nonresident Partners

Schedule KPI treats resident and nonresident partners differently in terms of what income is taxed, but the credit itself is generally calculated the same for all partners.3

• Resident Partners: A Minnesota resident partner is taxed by the state on their entire distributive share of partnership income, regardless of where that income was earned. For these individuals, the R&D credit reported on Schedule KPI reduces their total Minnesota tax liability.1
• Nonresident Partners: Nonresident individuals, estates, and trusts are only taxed on the income that is specifically apportioned to Minnesota. Their Schedule KPI will include additional information on Lines 36 through 55 (on the 2025 form) to help them determine their Minnesota-source distributive income.3 The R&D credit is then applied against the tax calculated on this Minnesota-source income.1

Composite Income Tax and Schedule KPI

Nonresident partners who have no other Minnesota-source income may elect to have the partnership pay their tax on a “composite” basis.19 If a partner makes this election, the partnership includes them on a single composite return and pays a flat tax (currently 9.85%) on their share of Minnesota income.4 The R&D credit from Schedule KPI, Line 26, is explicitly factored into this calculation to reduce the composite tax due for that partner.4 However, the state revenue office guidance clarifies that any partner receiving an installment sale gain reported on Line 7a or 7b is disqualified from participating in a composite return.4

Defining Qualified Research Expenses (QREs)

To arrive at the figure reported on Schedule KPI, the partnership must accurately identify and sum its QREs. These expenses are grouped into several primary categories, each with its own set of evidentiary requirements.14

Wages for Qualified Services

Wages constitute the largest component of most R&D credit claims, often accounting for 75% or more of the total credit value.8 To be eligible, the wages must be paid to an employee for “qualified services,” which include:

• Direct Research: Performing the actual technical work, such as coding, engineering, or scientific testing.14
• Direct Supervision: Managing the researchers and making technical decisions about the research path.8
• Direct Support: Providing essential assistance, such as a lab assistant cleaning equipment or a developer maintaining a testing environment.8

Minnesota explicitly excludes any wages used in figuring the federal Work Opportunity Tax Credit from being included in the state research credit calculation.20

Supplies and Tangible Property

The cost of supplies used in the conduct of qualified research is also eligible.17 This includes materials consumed during the testing and prototyping phase, such as chemicals, specialized components for a mock-up, or electricity used in a laboratory.14 It does not include general administrative supplies, land, or depreciable property.14

Contract Research Expenses

If a partnership hires a third party—such as a university lab or an outside engineering firm—to perform research on its behalf, 65% of those expenses may be included in the QRE calculation.7 For this to qualify, the research must still be performed within Minnesota, and the partnership must retain substantial rights to the research results while bearing the economic risk of the project’s failure.14

Computer Rentals and Cloud Computing

In the modern digital economy, the “right to use computers to conduct research” often refers to cloud computing and server rental costs.14 For these costs to qualify, the computers must be used at least 80% for the conduct of qualified research activities.14 This is a frequent area of focus for state auditors, who may require logs of server usage to substantiate the 80% threshold.

Qualified Nonprofit Contributions

A unique provision in Minnesota law allows for the inclusion of development contributions to specific nonprofit organizations.5 To qualify, the nonprofit must be operated for the purpose of making grants to small, technologically innovative enterprises in Minnesota during their early stages of development.5 These contributions are reported on Line 6 of Schedule RD before being factored into the total credit passed to partners via Schedule KPI.20

The 2025 Refundability Paradigm Shift: H.F. 9

The enactment of H.F. 9 in June 2025 introduced a transformative option for taxpayers receiving the research credit.12 For the first time in over a decade, the credit can once again provide an immediate cash infusion to businesses, albeit through a partial refund mechanism.13

The Refundability Rate and Calculation

The refundable portion of the credit is not a flat amount; it is calculated by applying a specific rate to the portion of the credit that remains after the partner’s tax liability has been reduced to zero.12

$$\text{Refundable Amount} = (\text{Current Year R&D Credit} – \text{Minnesota Tax Liability}) \times \text{Refundability Rate}$$

The legislature has established a schedule of rates that will increase over the coming years to manage the fiscal impact on the state budget.12

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The 2028 provision is particularly noteworthy, as it gives the Commissioner of Revenue the authority to adjust the rate downward if the total volume of refund claims statewide exceeds $25 million.14 The new rate must be published annually by December 15 based on November revenue forecasts.14

Election and Irrevocability

The choice between claiming a partial refund or carrying the full unused credit forward for 15 years rests with the individual partner.17 This election must be made on a timely filed return, including extensions, and once made, it is irrevocable for that tax year.12

This creates a strategic dilemma for partners. For instance, if a partner has $100,000 in unused credits in 2025:

• Refund Option: They can receive a cash check for $19,200 ($100,000 x 19.2%). However, the remaining $80,800 is forfeited and cannot be carried forward.12
• Carryforward Option: They can carry the full $100,000 forward for up to 15 years to offset future Minnesota tax liabilities at a 1:1 ratio.

For a partner in a high-growth startup that expects to be profitable and paying significant Minnesota taxes in two or three years, the carryforward may be worth five times more in long-term tax savings than the immediate refund. Conversely, for a partner in a business facing a liquidity crisis, the cash refund might be essential for continued operations.12

Calculation Methodologies: Base Amount and Fixed-Base Percentage

Determining the “Credit for Increasing Research Activities” requires calculating a “base amount,” which represents the taxpayer’s historical research effort. Minnesota uses the federal Regular Incremental Method but incorporates state-specific sales and gross receipts data.5

The Fixed-Base Percentage

The calculation begins with the “fixed-base percentage,” which is the ratio of the taxpayer’s aggregate QREs to aggregate gross receipts for the tax years 1984 through 1988.5 This percentage is capped at a maximum of 16%.20

For companies that did not exist or did not have both receipts and research expenses during that 1980s window—often referred to as “start-up companies”—Minnesota law assigns a statutory fixed-base percentage of 3% for the first five tax years after 1993 in which the company has QREs.5

Average Annual Gross Receipts

The fixed-base percentage is then multiplied by the average annual Minnesota gross receipts for the four tax years preceding the credit year.7 It is critical to note that “Minnesota gross receipts” refers specifically to the sales or receipts used for apportioning income to the state, not the company’s national or global revenue.5

The 50% Minimum Base Rule

To ensure the credit remains an incentive for new research rather than a subsidy for existing research, the base amount can never be less than 50% of the current year’s QREs.9

$$\text{Base Amount} = \max(\text{Fixed-Base \%} \times \text{Avg. Prior 4 Yrs MN Receipts}, \ 0.50 \times \text{Current Yrs QREs})$$

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This 50% floor often limits the credit for rapidly growing technology companies or established firms that have significantly increased their Minnesota research presence relative to their historical Minnesota sales.9

Audit Defense and Substantiation Standards

The Minnesota Department of Revenue has identified the research credit as a “complicated” area where guidance was historically limited, leading to a recent push for more rigorous documentation standards.17 Because the credit is passed to partners via Schedule KPI, an audit of the partnership’s research activities will impact every partner who claimed the credit.

The Contemporaneous Requirement

The most common reason for credit disallowance is the failure to maintain “contemporaneous records.” These are documents created at the same time the research was performed.17 The Department of Revenue explicitly states that “solely interviewing employees to reconstruct activities believed to qualify for the credit is generally insufficient”.17

The Documentation Portfolio

Partnerships should maintain a “Project Portfolio” that includes for each research project:

1. Technical Objectives: What specific technical uncertainty was being addressed? 17
2. Process of Experimentation: What alternatives were tested? How did the team iterate? 7
3. Personnel Logs: Who worked on the project, where were they located, and how many hours did they spend? 7
4. Evidence of Failure: Records of failed tests, bug logs, and discarded hypotheses are often the strongest evidence that a true “process of experimentation” occurred.7
5. Financial Nexus: Direct links between the payroll records, supply invoices, and specific qualified projects.7

Specific MDOR Requests

During a review or audit, the state revenue office may request specific certifications and external data, such as:

• A copy of the completed and signed certification statement filed with the IRS.17
• Documentation of any Innovation Grants received from the Department of Employment and Economic Development (DEED), as expenses funded by these grants must be subtracted from the QRE total.5
• Detailed lists of research activities describing how each process became “better” in terms of function, performance, reliability, or quality.17

Local Revenue Office Guidance: Filing and Administrative Compliance

Compliance with the R&D credit requires coordination between the partnership’s entity-level filing and the partner’s individual filing. The Minnesota Department of Revenue has issued several key directives to manage this process.2

Entity-Level Requirements (Form M3)

The partnership must file Form M3 (Partnership Return) by the 15th day of the fourth month following the close of the tax year (typically April 15).4 An automatic six-month extension is granted if any tax due is paid by the original due date.4

When claiming the research credit, the partnership must enclose:

• A completed Schedule RD.5
• A copy of Federal Form 6765.17
• Copies of all Schedules KPI issued to partners.4

Electronic Payment Mandate

Partnerships are generally required to pay their taxes and fees electronically through the Department’s website.4 Failure to do so can result in a 5% penalty, even if a paper check is sent on time.4 This is particularly relevant for partnerships making estimated tax payments for the minimum fee, nonresident withholding, or PTE tax.4

Estimated Tax Thresholds

A partnership must make quarterly estimated tax payments if the sum of its estimated minimum fee, nonresident withholding, and composite income tax, less any credits (including the R&D credit), is $500 or more.4

Comprehensive Scenario: The “Gopher Tech” Partnership Case Study

To synthesize the application of Schedule KPI and the research credit, consider “Gopher Tech LLC,” a Minnesota software partnership with two equal partners: Partner X (a MN resident) and Partner Y (a CA resident).

Step 1: QRE Identification

In 2025, Gopher Tech LLC spends:

• $1,000,000 on MN-based software developer wages.
• $100,000 on cloud server costs for testing prototypes.
• $100,000 on a contract with the University of Minnesota for a specialized AI study.
• Total QREs: $1,000,000 + $100,000 + ($100,000 x 65%) = $1,165,000.8

Step 2: Base Amount Calculation

The partnership’s average MN gross receipts for the last four years were $2,000,000. It is a start-up with a 3% fixed-base percentage.5

• Calculated Base: $2,000,000 x 0.03 = $60,000.
• 50% Minimum Base: $1,165,000 x 0.50 = $582,500.
• Final Base Amount: $582,500.5

Step 3: Credit Computation

Excess QREs = $1,165,000 – $582,500 = $582,500.

Because the excess is under $2,000,000, the 10% rate applies.

• Total Partnership Credit: $58,250.14

Step 4: Schedule KPI Allocation

The partnership issues a Schedule KPI to each partner.

• Partner X (Resident): Line 26 shows $29,125. Partner X also receives their full share of partnership income.2
• Partner Y (Nonresident): Line 26 shows $29,125. The schedule also details Partner Y’s Minnesota-source distributive income on Line 50 of the 2022/2024 forms (or Line 55 of the 2025 form) to allow for the calculation of their specific MN tax liability.3

Step 5: Individual Elections (2025 Impact)

Partner X has a MN tax liability of $40,000. They apply their $29,125 credit to reduce their tax to $10,875. They have no “unused” credit, so refundability is not an option.13

Partner Y has a MN tax liability of only $5,000.

1. They use $5,000 of the credit to reduce their tax to zero.
2. Unused Credit = $29,125 – $5,000 = $24,125.
3. Election A (Carryforward): Partner Y carries the full $24,125 forward for 15 years.
4. Election B (Refund): Partner Y elects a refund. They receive a check for $4,632 ($24,125 x 19.2%). The remaining $19,493 is forfeited.12

Interactions with Federal Nonconformity (H.R. 1)

A critical and often overlooked aspect of current Minnesota tax reporting is the state’s periodic “nonconformity” with federal tax changes. For the 2025 tax year, the state revenue office has issued warnings regarding the 2025 Federal Tax Budget and Reconciliation Bill (H.R. 1).4

Because Minnesota law is currently tied to the Internal Revenue Code as amended through May 1, 2023, any federal changes enacted after that date (including those in H.R. 1) do not automatically apply to Minnesota returns.4 Partnerships must use Schedule KPINC (for individual partners) and KPCNC (for corporate partners) to calculate and report the “nonconformity adjustments” necessitated by these differences.4 While this primarily affects the calculation of taxable income, it can indirectly impact the R&D credit by changing the tax liability against which the credit is applied.

Industry-Specific Impact and Future Outlook

The manufacturing and technology sectors continue to be the primary beneficiaries of the Minnesota research credit, but the 2025 changes are expected to broaden the appeal to other innovation-driven industries.8

• Agriculture and Food Science: Minnesota’s strong presence in crop R&D, food safety, and agricultural automation makes this sector a prime candidate for the partially refundable credit, particularly for firms developing new sustainable materials or processing techniques.15
• Bioscience and Medical Devices: With “Medical Alley” located in the Twin Cities, numerous startups in the biotech and medical device space will benefit from the ability to monetize credits during the long regulatory approval phases.14
• Software and Cybersecurity: The transition of the R&D credit toward cloud-based expenditures and the reintroduction of refundability align perfectly with the business models of SaaS companies that often operate at a loss while scaling their platforms.7

The state’s commitment to maintaining a $25 million annual refund target indicates a permanent shift toward using the tax code as a tool for direct capital assistance to innovators.14 As the refundability rate climbs toward 25% in 2026, the strategic importance of Schedule KPI as a document for financial planning—not just tax compliance—will only grow.

Conclusion

Schedule KPI remains the indispensable tool for partners seeking to unlock the value of the Minnesota Credit for Increasing Research Activities. By meticulously documenting qualified research expenses and understanding the tiered calculation and base amount rules, partnerships can generate significant tax benefits for their owners. The advent of partial refundability in 2025 provides a powerful new lever for cash management, though it requires careful strategic analysis by each individual partner to determine whether a partial immediate refund outweighs the long-term value of a full carryforward. In an environment of increasing audit scrutiny and evolving federal nonconformity, the integrity of the data reported on Schedule KPI is the ultimate safeguard for a partner’s research-based tax incentives. Navigating these complexities requires a disciplined approach to contemporaneous record-keeping and a proactive understanding of the Minnesota Department of Revenue’s technical directives. As the state continues to refine its incentive programs to compete in a global innovation economy, Schedule KPI will serve as the primary record of a taxpayer’s contribution to the technological advancement of the North Star State.

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