Comprehensive Analysis of Schedule KS and the Minnesota Credit for Increasing Research Activities: Legislative Evolution, Administrative Compliance, and Strategic Refundability

Schedule KS is the definitive pass-through reporting document used by S-corporations to allocate the Minnesota Credit for Increasing Research Activities to their shareholders for application against personal income tax liabilities. It serves as the administrative nexus between corporate-level research expenditures and individual-level tax incentives, facilitating the flow-through of state-sponsored innovation subsidies.

The complexity of the Minnesota Credit for Increasing Research Activities, colloquially known as the Research and Development (R&D) tax credit, stems from its dual-layered reporting requirements and its nuanced departure from federal tax standards. While the substantive calculation of the credit occurs at the entity level through the completion of Schedule RD, the realization of the tax benefit for S-corporation shareholders is dependent on the accurate execution of Schedule KS. This form essentially summarizes the shareholder’s pro-rata portion of various income, credits, and modifications generated by the S-corporation, with Line 26 specifically reserved for the R&D credit.1 To understand Schedule KS in its proper context, one must examine the underlying legal architecture provided by Minnesota Statute 290.068, which governs the eligibility of research activities, the categorization of qualifying expenses, and the recent legislative pivot toward partial refundability.2

The Statutory Framework: Minnesota Statute 290.068 and Federal Conformity

The Minnesota Credit for Increasing Research Activities is anchored in Minnesota Statute 290.068, which permits a credit against the corporate franchise tax or individual income tax for businesses that increase their investment in qualified research within the state boundaries.3 Although the Minnesota credit is largely modeled after the federal credit for increasing research activities found in Section 41 of the Internal Revenue Code (IRC), the state has established several distinct provisions that require careful navigation by tax professionals.

Under the state’s legal framework, the credit is intended to be incremental, rewarding businesses that expand their research efforts beyond a calculated base amount rather than subsidizing a static level of research spending.5 The statute identifies two primary tiers for the credit calculation: 10 percent of the first $2,000,000 of qualifying expenses in excess of the base amount, and 4 percent for any excess expenditures beyond that threshold.2 This tiered structure reflects a policy objective to provide a disproportionately higher incentive for small to mid-sized innovation projects while maintaining a consistent support mechanism for large-scale industrial research and development.6

A critical aspect of the Minnesota statute is its selective conformity to federal definitions. While Minnesota adopts the federal definition of “qualified research” and “qualified research expenses” (QREs) as defined in IRC Section 41(b) and (d), it enforces a strict geographic limitation: all research activities must be conducted entirely within the state of Minnesota to be eligible for the credit.2 This necessitates a rigorous accounting of employee time and contractor performance locations, as any expenditures incurred for research performed outside Minnesota must be excluded from the state-level calculation.2

Defining Qualified Research: The Four-Part Test in a Local Context

For an activity to generate the credit reported on Schedule KS, it must first satisfy the “Four-Part Test” derived from federal law but applied through the lens of Minnesota Department of Revenue (MDOR) guidance. Each component must be documented contemporaneously to survive administrative scrutiny.2

The Permitted Purpose Requirement

The research must be conducted for a “permitted purpose,” meaning it is intended to result in a new or improved business component. Under Minnesota guidance, this includes the development of products, processes, computer software, techniques, or formulas that exhibit improved function, performance, reliability, or quality.2 Routine data collection, market research, or aesthetic improvements—such as changes to the style, taste, or cosmetic design of a product—are explicitly excluded from the definition of qualified research.2

The Elimination of Uncertainty

A central tenet of the R&D credit is the “elimination of uncertainty.” The taxpayer must demonstrate that the activity was undertaken to discover information that would eliminate technical uncertainty regarding the capability or method for developing or improving a product, or the appropriateness of the product’s design.2 If the outcome is predictable or achievable through standard engineering protocols without technical risk, the activity likely falls outside the statutory definition of qualified research.

The Process of Experimentation

Taxpayers must engage in a systematic process of experimentation. This involves the evaluation of alternatives through a series of steps such as developing a hypothesis, testing that hypothesis through modeling, simulation, or systematic trial and error, and subsequently refining or discarding the hypothesis based on the results.2 The MDOR emphasizes that a successful outcome is not a prerequisite for the credit; rather, it is the systematic attempt to overcome technical obstacles that qualifies the work.

Technological in Nature

Finally, the research must be “technological in nature,” meaning the process of experimentation must fundamentally rely on the principles of physical science, biological science, engineering, or computer science.6 While the discovery of information does not need to be “new to the world,” it must be new to the taxpayer and based on hard science rather than social sciences or humanities.

Categorization of Qualified Research Expenses (QREs)

The credit passed through on Schedule KS is derived from a pool of specific expenditures identified on Schedule RD. These expenditures are categorized into five primary buckets under Minnesota law 2:

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The inclusion of nonprofit contributions as a qualified expense is a unique feature of the Minnesota credit that distinguishes it from the federal counterpart. This provision is designed to foster a broader innovation ecosystem by incentivizing established companies to support small, technologically innovative firms through qualifying nonprofit organizations.4 However, it is important to note that expenditures funded by “Innovation Grants” from the Minnesota Department of Employment and Economic Development (DEED) are explicitly ineligible for the credit, as the state seeks to prevent “double-dipping” into government subsidies for the same research activity.1

The Incremental Base Amount: Rationale and Calculation

The Minnesota R&D credit is structured as an incremental incentive, meaning it only applies to the portion of research spending that exceeds a historical “base amount.” This structure ensures that the state only provides tax benefits for “increased” effort rather than subsidizing research that the business would have conducted as a normal part of its operations.5

The calculation of the base amount in Minnesota differs from the federal method in its definition of gross receipts. While the federal credit utilizes national gross receipts, the Minnesota base amount is calculated using Minnesota sales or receipts as defined under the state’s apportionment statutes.2

The Traditional Calculation Method

The base amount is generally determined by multiplying the taxpayer’s “fixed-base percentage” by the average annual Minnesota gross receipts for the four tax years preceding the credit year.1 For established companies that were active between 1984 and 1988, the fixed-base percentage is the ratio of their aggregate QREs to their aggregate gross receipts during that period, capped at a maximum of 16 percent.1

For newer companies—those that do not have at least three years of both Minnesota receipts and QREs during the 1984-1988 period—the statute provides a “start-up” fixed-base percentage of 3 percent for the first five tax years after 1993.1 This lower entry point allows newer innovative firms to access the credit more quickly than if they were held to a higher historical average.

The 50 Percent Floor

A significant statutory limitation, often referred to as the “50 percent floor,” stipulates that the base amount can never be less than 50 percent of the current year’s QREs.5 This means that the “creditable dollars”—the amount of spending that actually generates the 10 percent or 4 percent credit—can never exceed half of the company’s total qualifying research expenditure for the year.13 This provision acts as a safety valve for the state’s general fund, ensuring that even the most rapidly expanding companies cannot eliminate their entire tax liability through a single year of massive research growth.

Pass-Through Mechanics: Reporting via Schedule KS

For S-corporations, the R&D credit is not applied at the entity level but is instead passed through to shareholders. This process requires a coordinated reporting effort involving multiple state forms.1

Step 1: Corporate Calculation on Schedule RD

The S-corporation begins by completing Schedule RD, where it aggregates all Minnesota-specific QREs, calculates the base amount, and determines the total tentative credit generated by the business. At this stage, the corporation must also disclose details regarding its research activities, including a description of the improvements sought and the experimentation process employed.2

Step 2: Allocation to Shareholders via Schedule KS

Once the total credit is calculated on Schedule RD, it is allocated among the shareholders in proportion to their ownership interest in the S-corporation. Each shareholder’s portion is recorded on their individual Schedule KS, specifically on Line 26.1

It is important to note that shareholders who elect to file a “composite return”—a simplified filing where the corporation pays tax on behalf of non-resident shareholders—are generally ineligible to claim the R&D credit.1 To benefit from the credit, these shareholders must file an individual Minnesota income tax return (Form M1).

Step 3: Individual Claim on Form M1

The individual shareholder receives the Schedule KS and must then report the R&D credit on Schedule M1C (Other Nonrefundable Credits). The credit is used to reduce the shareholder’s personal income tax liability. For tax years prior to 2025, if the credit exceeded the tax liability, it was non-refundable and could only be carried forward for up to 15 years.2

The Transformation of 2025: Partial Refundability

One of the most significant shifts in Minnesota tax policy occurred with the passage of House File 9 (HF 9) in 2025. This legislation fundamentally altered the R&D credit by introducing a partial refundability option, providing a vital source of liquidity for startups and R&D-heavy firms that have not yet reached profitability.7

The Refundability Rates and Timeline

Starting with tax years beginning after December 31, 2024, taxpayers—including shareholders receiving credits via Schedule KS—can elect to receive a cash refund for a portion of their unused R&D credits.2 The legislation establishes a scaling refundability rate to manage the state’s fiscal exposure:

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The refund calculation is applied to the “excess” credit—the amount of current-year credit that remains after the taxpayer’s liability has been reduced to zero by all other available credits and the non-refundable portion of the R&D credit itself.2

The Election Process and Irrevocability

The election to claim a refund is made at the individual level for S-corporation shareholders.2 A shareholder must make this election on a timely filed original return (including any extensions). Crucially, once the election is made for a specific tax year, it is irrevocable.17 Taxpayers must carefully weigh the immediate cash benefit of a partial refund against the long-term value of a 100 percent carryforward, which could offset future taxes at a much higher effective rate.

The $25 Million Statewide Cap

To ensure the fiscal sustainability of the refundability provision, the state has implemented a statewide cap of $25 million per year for total R&D credit refunds, effective for the 2028 tax year and beyond.6 If the Minnesota Department of Revenue projects that the total amount of refunds requested will exceed $25 million, it is required to adjust the refundability rate downward for all taxpayers to keep the total expenditure within the cap.6 This adjusted rate must be published annually by December 15 of the year preceding the tax year.7

Administrative Guidance and Compliance Requirements

The Minnesota Department of Revenue (MDOR) has issued extensive guidance to ensure that credits claimed on Schedule KS are substantiated by robust evidence. The burden of proof lies with the taxpayer to demonstrate that the expenses were incurred for qualified research conducted within the state.2

Documentation of Research Activities

Taxpayers are expected to maintain an “innovation log” or similar records that capture the timeline of research projects. This documentation should include:

• Project authorization records and procedure manuals.2
• Detailed descriptions of the technical uncertainties identified at the outset of each project.2
• Records of the alternatives evaluated and the results of various testing protocols.2
• Documentation of the specific employees and contractors involved, including time-tracking data that confirms the research was performed in Minnesota.2

Supply Record Maintenance

For supply expenses to be eligible, they must be tangible property used directly in the research process. MDOR guidance specifies that general and administrative supplies, such as travel, telephone expenses, or general inventory, do not qualify.2 Taxpayers should maintain invoices and a list of physical supplies consumed, specifically noting the quantities used for qualified activities.2

Contract Research Verification

When using contractors, 65 percent of the expense is generally qualifying, provided the research is performed in Minnesota. Taxpayers must verify the location of the contractor’s performance.9 If the research is performed on behalf of another entity (e.g., under a “funded research” contract), the entity paying for the research may not be entitled to the credit if the performing contractor retains the substantial rights to the research results.14

Unitary Business Groups and Credit Allocation

For corporations and entities that are part of a unitary business group, Minnesota law provides specific rules for the utilization and allocation of the R&D credit. This is particularly relevant for complex business structures where research may be conducted in one subsidiary while revenue is generated in another.10

The 2020 Updated Guidance

In June 2020, the MDOR updated its guidance regarding the application of R&D credit carryforwards within unitary groups. The current rules establish a specific order of utilization:

1. Earning Member Priority: The current-year credit must first be used by the specific member of the group that generated the research (the “earning member”) to offset its own tax liability.10
2. Group-Wide Sharing: Any remaining current-year credit can then be allocated to other members of the unitary group to offset their respective tax liabilities.1
3. Carryforward Sharing: Unused credits are carried forward by the earning member. Crucially, the 2020 update clarified that these carryforward credits can also be shared with other members of the unitary group in subsequent years, whereas previously they were often restricted to the earning member.10

This “group-wide” utilization significantly enhances the value of the credit for consolidated filers, as it prevents the “trapping” of credits in pre-revenue or research-focused subsidiaries while other profitable members of the same group pay full state tax.11

Mathematical Example: Shareholder Allocation and Refund Election

To illustrate the interplay between Schedule RD, Schedule KS, and the new 2025 refundability rules, consider a hypothetical Minnesota S-corporation with two equal shareholders.

Corporate Level: “AgriTech Innovations S-Corp” (Tax Year 2025)

AgriTech develops automated crop monitoring software in St. Paul, MN.

• Current Year MN QREs: $1,200,000
• Average MN Gross Receipts (Prior 4 Years): $5,000,000
• Fixed-Base Percentage: 4%
• Tentative Base Amount Calculation: $5,000,000 \times 0.04 = $200,000
• 50% Floor Application: $1,200,000 \times 0.50 = $600,000
• Statutory Base Amount: $600,000 (Greater of $200,000 or $600,000)
• Excess QREs: $1,200,000 – $600,000 = $600,000
• Credit Calculation: $600,000 \times 10% = $60,000

AgriTech completes Schedule RD and allocates $30,000 to each shareholder via Schedule KS, Line 26.1

Shareholder Level: Shareholder Jane (Tax Year 2025)

Jane owns 50 percent of AgriTech and has other Minnesota sources of income.

• Jane’s MN Tax Liability (Before R&D Credit): $10,000
• R&D Credit from Schedule KS: $30,000
• Utilization of Credit: Jane uses $10,000 of the credit to reduce her liability to $0.
• Excess Credit Remaining: $20,000
• Election Scenario A: Carryforward only. Jane carries forward the full $20,000 to 2026.
• Election Scenario B: Partial Refund. Jane elects a refund for the excess.
• Refund Calculation: $20,000 \times 19.2% (\text{2025 rate}) = $3,840.
• Remaining Carryforward: $20,000 – $3,840 = $16,160.

In Scenario B, Jane receives an immediate cash payment of $3,840 from the state but reduces her potential future tax offset by the same amount. This demonstrates the liquidity-versus-value trade-off inherent in the new law.2

Quantitative Impact and Statistics

The Minnesota R&D credit is a primary driver of the state’s innovation policy, with an annual fiscal impact that has steadily grown. The introduction of the refundability option is projected to increase state expenditures, prompting the legislature to implement the $25 million refund cap to maintain budgetary control.6

Historical and Projected Tax Expenditure

The cost of the credit is split between the Corporate Franchise Tax and Individual Income Tax (via pass-through entities like S-corporations and partnerships).

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The projected jump for 2026 and beyond reflects the “monetization” of previously unusable carryforwards through the new refundability election, particularly as more taxpayers become aware of the cash-out option.16

Strategic Implications of IRC Section 174 Amortization

A critical external factor affecting the R&D credit is the federal requirement under the Tax Cuts and Jobs Act (TCJA) to capitalize and amortize research expenses. Starting in 2022, businesses can no longer deduct R&D expenses in the year they are incurred; instead, they must spread the deduction over five years for domestic research.5

While this change primarily affects the calculation of taxable income, it has a circular effect on the Minnesota R&D credit. By increasing current-year taxable income (since the deduction is smaller), the amortization requirement may increase the current-year tax liability for many shareholders. This, in turn, may lead to a higher utilization of the R&D credit to offset the increased tax, potentially leaving less “excess” credit available for the 2025 refund election. Taxpayers must coordinate their Section 174 amortization schedules with their Schedule RD calculations to ensure a complete picture of their tax position.5

Conclusion

The interaction between Schedule KS and the Minnesota Credit for Increasing Research Activities provides a powerful mechanism for fueling innovation by allowing S-corporation shareholders to directly benefit from the company’s research investments. The legislative evolution of 2025, which introduced partial refundability, marks a new era in Minnesota tax policy, shifting the R&D credit from a mere tax offset to a potential source of direct capital for growing enterprises.

However, the realization of these benefits is predicated on strict adherence to both statutory requirements and administrative guidance. From the rigorous “Four-Part Test” for qualifying activities to the precise calculation of the Minnesota-specific base amount and the strategic choice between refundability and carryforward, taxpayers must manage their R&D claims with a high degree of technical precision. As the state moves toward a capped refund environment in 2028, the importance of contemporaneous documentation and proactive tax planning will only increase. For Minnesota’s business community, the R&D credit remains a cornerstone incentive, provided that the reporting on Schedule KS is backed by the substantial evidence and nuanced understanding required by the Department of Revenue.

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