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

Schedule RD is the statutory tax form required by the Minnesota Department of Revenue to calculate and claim the Credit for Increasing Research Activities for qualified expenditures conducted within the state. It functions as a bridge between federal definitions of research and state-specific fiscal policy, allowing businesses to reduce their income or franchise tax liability through a tiered, incremental credit structure.1

The Minnesota Credit for Increasing Research Activities—often referred to as the R&D Tax Credit—represents one of the most significant fiscal tools the state employs to incentivize technological innovation and high-wage job creation. Established in 1981 and modeled after the federal credit under Internal Revenue Code (IRC) Section 41, the credit has undergone several legislative evolutions to adapt to changing economic landscapes, most notably the transition toward partial refundability for tax years beginning after December 31, 2024.4 For a business to successfully claim this credit, it must navigate the complexities of Schedule RD, which requires a rigorous accounting of “Qualified Research Expenses” (QREs) and a precise determination of the “Base Amount.” This analysis explores the legal framework of Minnesota Statute Section 290.068, the operational requirements of Schedule RD, and the strategic implications of the 2025 refundability election.

Legislative Context and Statutory Purpose of Section 290.068

The Minnesota Credit for Increasing Research Activities is governed by Minnesota Statutes Section 290.068, a provision designed to stimulate the state’s economy by rewarding private investment in research and development.7 While the statutory language does not always contain an explicit statement of purpose, the Minnesota Office of the Legislative Auditor has identified three primary goals: the creation or retention of high-quality jobs, the overall increase of research activity within the state’s borders, and the attraction or retention of innovation-based businesses.6 Since its inception in 1981, the credit has matured from a simple deduction into a complex, tiered tax credit that remains one of the state’s largest tax expenditures, with annual costs projected to exceed $150 million by fiscal year 2025.9

The credit is fundamentally incremental, a design choice intended to ensure that state funds are used to incentivize additional research effort rather than subsidizing the “normal” or baseline research a company would perform in the ordinary course of business.9 By requiring taxpayers to exceed a calculated “base amount” before receiving the credit, the legislature ensures that the benefit is tied to growth in innovation. This structure, while mirroring federal law, incorporates several unique Minnesota deviations that require careful analysis through the lens of Schedule RD.1

The Legal Definition of Qualified Research in Minnesota

To understand Schedule RD, one must first master the definition of “Qualified Research” as it applies in the State of Minnesota. The state largely adopts the federal definitions found in IRC Section 41(d), but with one critical and absolute restriction: the research must be conducted entirely within the state of Minnesota.1

The Four-Part Test for Activity Qualification

For any activity to be reported on Schedule RD, it must satisfy the “Four-Part Test” established under federal regulations and adopted by the Minnesota Department of Revenue.1 The failure to meet even one of these criteria renders the associated expenses ineligible for the credit.

The first requirement is the Section 174 Test, which dictates that the expenditures must qualify as a business deduction under Section 174 of the Internal Revenue Code.1 This means the costs must be incurred in connection with the taxpayer’s trade or business and represent research and development costs in the experimental or laboratory sense, aimed at eliminating uncertainty concerning the development or improvement of a product.1

The second requirement is the Technological in Nature Test. The research must rely on the principles of the physical or biological sciences, engineering, or computer science.1 Activities rooted in the social sciences, humanities, or business management do not qualify.1

The third requirement is the Process of Experimentation Test. This is arguably the most scrutinized part of the test during a state audit. The taxpayer must demonstrate that substantially all of the activities constitute a process of experimentation, which involves identifying a technical uncertainty, forming a hypothesis, testing that hypothesis through the evaluation of alternatives, and refining or discarding the hypothesis based on results.1

The fourth requirement is the Business Component Test. The research must be intended to discover information that results in a new or improved business component, which is defined as a product, process, computer software, technique, formula, or invention to be held for sale, lease, or license, or used by the taxpayer in their trade or business.1

Excluded Activities and Statutory Carve-outs

Minnesota law explicitly excludes several types of activities from the definition of qualified research. These exclusions are critical for taxpayers to understand when preparing Schedule RD to avoid overstating their claim 1:

• Research after Commercial Production: Any research conducted after the beginning of commercial production of a business component is ineligible.1
• Adaptation of Existing Components: Activities related to the adaptation of an existing business component to a particular customer’s requirement or need are excluded.1
• Duplication of Existing Components: Research related to the reproduction of an existing business component from a physical inspection, plans, blueprints, or similar documents is disqualified.1
• Surveys and Studies: Efficiency surveys, management studies, consumer surveys, and market research are not considered qualified research.1
• Internal Use Software: Software developed primarily for internal use is subject to much higher scrutiny and additional tests under federal and state law.1

Furthermore, any research funded by a grant, contract, or otherwise by another person or governmental entity is generally excluded as “funded research”.11 Specifically, Minnesota guidance notes that Innovation Grant expenditures from the Minnesota Department of Employment and Economic Development (DEED) are not eligible qualified research expenses.1

Categorization of Qualified Research Expenses (QREs)

The “Qualified Research Expense” is the basic unit of the Minnesota R&D credit. Schedule RD requires taxpayers to aggregate these expenses into specific categories, each with its own documentation and nexus requirements.1

Wages for Qualified Services (Line 1)

Wages typically represent the largest portion of any R&D claim, often exceeding three-quarters of the total QREs for Minnesota C corporations.6 These include all remuneration for services performed by an employee that would be considered “wages” for federal income tax purposes.12 To be included on Line 1 of Schedule RD, the employee must have been performing “qualified services,” which include:

1. Engaging in Qualified Research: This is the direct performance of the experimentation or technical work.12
2. Direct Supervision: This covers individuals who are the immediate supervisors of those performing the research.1
3. Direct Support: This includes services provided by employees who support the research, such as a lab technician cleaning equipment or a machinist building a prototype for an experimental design.1

A key “safe harbor” exists for wages: if an employee performs qualified services at least 80% of the time, 100% of their wages may be included in the QRE calculation.18 However, if their time falls below 80%, only the actual portion of their wages dedicated to qualified research may be claimed.12

Cost of Supplies (Line 2)

Supplies are defined as any tangible property other than land, improvements to land, and property of a character subject to the allowance for depreciation.1 This means capital equipment, like a $50,000 laboratory centrifuge, is excluded, but the $5,000 worth of chemicals and test tubes consumed during an experiment would qualify.1 Supplies used in Minnesota research must be consumed within the state to qualify for the Minnesota credit.1

Computer Rental and Cloud Costs (Line 3)

In the modern innovation economy, Line 3 has become increasingly important. It allows for the inclusion of amounts paid to another person for the right to use computers to conduct research.1 Under modern guidance, this is widely interpreted to include cloud computing costs—such as Amazon Web Services (AWS) or Microsoft Azure—provided the server time is used to host developmental environments, perform complex simulations, or store experimental data sets.18

Contract Research Expenses (Line 4)

Many businesses outsource specialized portions of their research to university labs or third-party engineering firms. Minnesota allows taxpayers to claim 65% of the amount paid for contract research, provided the research is conducted within Minnesota.2 The 35% statutory reduction is intended to exclude the contractor’s overhead and profit margins from the credit base.6 For these expenses to be eligible, the taxpayer must have a written agreement in place before the research begins, must retain substantial rights to the results, and must be responsible for the payment regardless of whether the research is successful.11

Basic Research and Nonprofit Contributions (Lines 5 and 6)

Line 5 pertains to payments for basic research made to qualified organizations, such as the University of Minnesota or other scientific research organizations.1 Line 6 is a unique Minnesota feature: it allows for “development contributions” to a nonprofit organization that awards grants to small, technologically innovative firms.1 This incentivizes larger corporations to fuel the startup ecosystem in the state.3

The Tiered Credit Rate Structure

Minnesota’s R&D credit is not a flat percentage. It utilizes a two-tiered system that provides a higher rate of return on the initial “slice” of research investment.1 For taxable years beginning after December 31, 2016, the rates are as follows:

Source: 1

Prior to 2017, the second-tier rate was only 2.5%, but the legislature increased it to 4% to remain competitive with other states that were aggressively courting R&D-heavy industries.1 This tiered structure means that a company with $1 million in excess QREs would receive a $100,000 credit, while a company with $3 million in excess QREs would receive $240,000 ($200,000 for the first $2 million and $40,000 for the final $1 million).1

Calculating the Base Amount: The Heart of Schedule RD

The “Base Amount” is the most complex calculation on Schedule RD and is the primary area where taxpayers make errors. The base amount represents the level of research spending a company would likely have undertaken without the incentive of the credit.9

The Fixed-Base Percentage (Line 14)

For established companies, the fixed-base percentage is calculated based on historical data from 1984 to 1988.9 It is the ratio of aggregate qualified research expenses to aggregate gross receipts for those five years.7 By law, this percentage is capped at a maximum of 16%.7

For “start-up” companies—those that did not have both QREs and gross receipts in at least three years during the base period—the code provides a “start-up” percentage.9 This is initially set at 3% for the first five years and then transitions toward an actual experience-based percentage over the next five years.23

Average Annual Gross Receipts (Line 20)

The next component is the average annual gross receipts for the four taxable years preceding the current credit year.9 A critical distinction for the Minnesota credit is that these must be “Minnesota sales or receipts” as defined in Section 290.191.7

This requirement was the subject of significant litigation in the case of General Mills, Inc. v. Commissioner of Revenue.20 The court ultimately affirmed that while the definition of the base amount follows federal IRC Section 41, the calculation of gross receipts for the Minnesota credit must use Minnesota-apportioned sales.20 This is generally advantageous for Minnesota-based multistate corporations because their Minnesota-specific sales are often a small fraction of their global sales, leading to a lower base amount and a higher credit.9

The 50% Minimum Base Amount Rule (Line 22)

Regardless of a company’s historical spending or sales growth, the base amount cannot be less than 50% of the current year’s qualified research expenses.9 This “floor” ensures that a company can never claim a credit on more than half of its current-year R&D expenditures.9 If the calculated base (Fixed-Base Percentage $\times$ Average Gross Receipts) is lower than 50% of current QREs, the 50% figure must be used as the base amount.16

The Refundability Revolution of 2025

Perhaps the most significant legislative change in the history of the Minnesota R&D credit was the enactment of House File 9 (HF 9) in June 2025.4 Starting for taxable years beginning after December 31, 2024, the credit became partially refundable, providing a massive cash-flow boost to pre-profit startups and R&D-heavy firms with low tax liability.5

Refundability Rates and Mechanics

If a taxpayer’s current-year R&D credit exceeds their tax liability (after all other credits have been applied), they can now elect to receive a cash refund for a portion of the unused credit.1 The refundability rates are established by statute to phase in:

Source: 1

The Commissioner’s Discretion and the $25 Million Target

To manage the state’s budget, the legislature set an annual “target” of $25 million for total refunds statewide.4 Starting in 2028, the Commissioner of Revenue will determine the refundability rate annually based on revenue forecasts.4 If the projected refunds exceed $25 million, the rate may be reduced below 25% for that year to maintain fiscal control.4 This creates a “floating” benefit that taxpayers must monitor as they do their long-term financial planning.13

Making the Election

The election to receive a refund is made by checking a specific box on Schedule RD (Line 37 on the 2025 form).23 The election must be made on a timely filed return, including extensions, and once made, it is irrevocable for that tax year.1 Taxpayers who do not elect the refund will continue to carry their unused credits forward for up to 15 years.1

Detailed Guidance for Schedule RD Navigation

Completing Schedule RD requires a disciplined approach to data entry across 47 individual lines.23 The form is divided into sections that mirror the logical flow of the credit calculation.23

Identification and Initial QRE Aggregation (Lines 1–7)

The taxpayer must provide their Name, Federal Employer Identification Number (FEIN), and Minnesota Tax ID.23 Lines 1 through 6 are used to enter the raw Minnesota QREs for the year, and Line 7 provides the total.23

Base Amount Calculation (Lines 8–23)

This section requires historical data. Lines 8 through 12 require both Minnesota Sales and QREs for the base years 1984 through 1988.23 Line 14 calculates the Fixed-Base Percentage, while Lines 15 through 18 require the Minnesota sales for the four years preceding the tax year.22 Line 20 computes the Average Annual Gross Receipts, and Line 23 determines the final Base Amount (choosing the larger of the calculated base or the 50% floor).16

Current Credit and Sharing (Lines 24–35)

Line 24 calculates the “Excess” QRE.16 Lines 25 through 29 apply the 10% and 4% tiered rates to arrive at the “Current Credit”.16 For unitary businesses, Line 34 is used to allocate portions of the credit to other members of the combined group who have tax liability to offset.10

Refundability and Carryovers (Lines 36–47)

Line 36 determines the unused portion of the credit.23 Line 37 is the critical new field for 2025: the Refundable Credit Amount.23 Line 38 subtracts the refund from the unused credit to find the remaining balance that will be carried forward to the following year.23 The final line, Line 47, calculates the total carryover to the next tax year (e.g., 2026).15

Unitary Business Groups and Credit Allocation

Minnesota requires unitary businesses—groups of related corporations with common ownership and integrated operations—to file a combined report.1 This filing method has significant implications for how the R&D credit is managed on Schedule RD.10

The Earning Member Rule

Each corporation within a unitary group that has qualified research expenses must complete its own separate Schedule RD.22 The credit is first applied to the tax liability of the “earning member”—the specific entity that incurred the expenses.1

Intra-Group Sharing of Excess Credits

If the earning member’s credit exceeds its own tax liability, the excess can be shared with other members of the same combined group to reduce their Minnesota tax liability.1 This is a “use-it-or-lose-it” rule for the current year: if any member of the group has tax liability, the group must use any available current-year R&D credits from other members before carrying any amount forward.10

Carryover Priority

When a company has both current-year credits and carryover credits from prior years, the law dictates a specific order of use. Carryover credits must be used by the earning member first in subsequent years.10 Only after the earning member has reduced its own tax liability to zero can the remaining carryover credit be shared with other group members.10 This prevents companies from “cherry-picking” which entities use which credits and ensures a systematic depletion of the state’s tax debt.10

Reporting for Partnerships and S Corporations

Pass-through entities do not pay the corporate franchise tax directly on their income. Instead, the tax liability—and the associated R&D credit—flows through to the individual partners or shareholders.1

Schedule KPI and Schedule KS

The partnership or S corporation calculates the total R&D credit for the entity by completing Schedule RD.15 This total is then allocated pro-rata to each owner.2

• For partnerships, the share is reported to each partner on Schedule KPI, Line 26.2
• For S corporations, the share is reported to each shareholder on Schedule KS, Line 26.2

The Individual Taxpayer’s Role

The individual owners take the amount from their K-1 equivalent and report it on their own Minnesota individual income tax return (Form M1).2 They must also include a copy of the Schedule RD from the entity and their own Schedule M1C (Other Nonrefundable Credits).2 Importantly, if the pass-through entity generates an R&D credit, the election to receive the refundable portion is made by the individual partners or shareholders, not by the entity itself.1

Documentation and Audit Preparedness: Building a Defense

The Minnesota Department of Revenue (MDOR) is known for its rigorous audits of R&D credit claims. Because the credit represents a significant reduction in tax revenue, the state demands high-quality, contemporaneous evidence that the research occurred and that the costs were accurately captured.1

The Innovation Log and Contemporaneous Records

The most successful taxpayers during an audit are those who maintain an “Innovation Log” or similar project management system.2 MDOR guidance specifies that documentation should show the scope of the research, the testing of alternatives, and the results of those tests.1

Critical documents include:

• Project Authorization Records: Showing when a project was started and what uncertainty it was intended to resolve.1
• Lab Reports and Lab Schedules: Documenting the actual experiments conducted.1
• Testing Protocols and Results: Evidence of the evaluation of alternatives.1
• Payroll Records: Time-tracking data that clearly links specific hours to specific qualified projects.1
• Supply Invoices: Receipts that identify the materials used and proof they were used in the research process.1

Audit Triggers and MDOR Review Processes

The Department of Revenue may request documentation for each tax period a credit is claimed.1 Common audit triggers include:

• Significant Year-over-Year Increases: A sudden spike in R&D spending without a corresponding increase in revenue or headcount.20
• High Ratio of R&D to Sales: If research spending is disproportionately high relative to the industry average.6
• Use of Third-Party Consultants: Schedule RD explicitly asks if a CPA or consultant assisted in the calculation or conducted a study.16 While common, this information helps auditors identify claims that may be more aggressive in their interpretations of the law.23

Comprehensive Example: “Lakeside Biotech LLC”

To illustrate the multifaceted application of the Minnesota R&D credit and Schedule RD, consider the hypothetical case of Lakeside Biotech LLC, an S corporation based in Rochester, Minnesota.

1. Activity Profile

Lakeside Biotech is developing a new delivery mechanism for a pharmaceutical compound. In 2025, they incurred the following costs within Minnesota:

• Wages: $800,000 for three researchers (100% time) and one lab manager (50% time).
• Supplies: $150,000 in specialized chemical reagents.
• Contract Research: $200,000 paid to a local university lab to perform stability testing.
• Computer Use: $50,000 for high-performance cloud computing time to model molecular interactions.

2. Aggregating QREs (Schedule RD, Lines 1–7)

• Line 1 (Wages): $800,000 $\times$ 1.0 (Researchers) + $100,000 (50% of Manager’s $200k salary) = $900,000.12
• Line 2 (Supplies): $150,000.1
• Line 3 (Computer Use): $50,000.1
• Line 4 (Contract Research): $200,000 $\times$ 0.65 = $130,000.2
• Line 7 (Total QREs): $900k + $150k + $50k + $130k = $1,230,000.23

3. Calculating the Base Amount (Schedule RD, Lines 8–23)

Assume Lakeside Biotech is a start-up with the following history:

• Fixed-Base Percentage (Line 14): 3% (Start-up rate).9
• Average Annual Gross Receipts (Line 20): $2,000,000 (Average of last 4 years of MN sales).
• Calculated Base (Line 21): $2,000,000 $\times$ 0.03 = $60,000.16
• Minimum Base Floor (Line 22): $1,230,000 $\times$ 0.50 = $615,000.18
• Final Base Amount (Line 23): $615,000 (The larger of $60k or $615k).16

4. Tiered Credit and Refundability (Lines 24–38)

• Excess QRE (Line 24): $1,230,000 – $615,000 = $615,000.16
• Tier 1 Credit (Line 27): $615,000 $\times$ 0.10 = $61,500.1
• Total Current Year Credit (Line 31): $61,500.16

Assume the sole owner has a personal Minnesota tax liability of $10,000 from this business.

• Credit Applied to Tax: $10,000.1
• Unused Credit (Line 36): $61,500 – $10,000 = $51,500.23
• Refundable Election (Line 37): $51,500 $\times$ 19.2% (for 2025) = $9,888.4
• Carryforward to 2026 (Line 47): $51,500 – $9,888 = $41,612.2

Through this filing, the owner eliminates their $10,000 tax bill, receives a nearly $10,000 check from the state, and still has $41,612 in credits “in the bank” for future years.1

Economic Impact and Legislative Scrutiny

The Minnesota R&D credit is one of the most significant line items in the state’s tax expenditure budget.27 The Department of Revenue regularly publishes data that allows policymakers to evaluate whether the credit is meeting its intended objectives.9

Historical and Projected Fiscal Data

The total cost of the credit has seen a sharp upward trajectory over the last several years, driven by both organic growth in the state’s tech sectors and legislative increases to the credit rates.9

Source: 9

While these numbers show high utilization, they have also prompted some skepticism from the Legislative Auditor’s office.6 A 2017 evaluation suggested that while the credit generates jobs and earnings, the growth is relatively small compared to the total revenue lost, and the credit “did not pay for itself” in terms of immediate fiscal benefits.6 However, proponents of the credit, including state legislators like Rep. Kristin Robbins, argue that the credit is essential to prevent “brain drain” to other states that offer more competitive alternative simplified methods.28

Industry Distribution of the Credit

The manufacturing industry remains the dominant force in Minnesota R&D, capturing roughly 65% of the total credits claimed by C corporations.6 This is followed by Professional, Scientific, and Technical Services (13%) and Management of Companies (13%).6 These three sectors account for 91% of the total credit volume, highlighting the concentrated nature of industrial innovation in the state.6

The Future Outlook: 2028 and Beyond

As Minnesota enters the era of refundable R&D credits, the landscape for taxpayers will continue to shift. The introduction of the “floating” refundability rate starting in 2028 represents a new level of complexity for tax directors and business owners.4 By December 15 of each year, the Commissioner will publish the rate for the following tax year based on the November revenue forecasts.13

Businesses will need to perform sophisticated cash-flow modeling to decide whether to take a smaller, immediate refund or wait and carry the full credit forward into a future year where they expect higher tax liability.13 This strategic decision-making process will become a central part of the annual Minnesota tax filing cycle.

Final Summary and Professional Recommendations

Schedule RD is the definitive record of a company’s innovation footprint in the State of Minnesota. Mastering this form requires a deep understanding of the interplay between federal tax law (IRC Sections 41 and 174) and Minnesota’s unique statutory deviations.1

For businesses looking to maximize their benefit while minimizing audit risk, several professional practices are recommended:

1. Maintain Contemporaneous Evidence: Do not wait for an audit to compile your R&D documentation. Build a system that captures innovation logs, time tracking, and supply receipts in real-time.1
2. Evaluate the Refundability Election: For startups and firms in a loss position, the 2025 refundability option provides critical liquidity. Perform a three-to-five-year tax liability projection before making the irrevocable election on Line 37.1
3. Navigate the Unitary Rules: Large groups must carefully manage the “earning member” rule and the sharing requirements to ensure credits are utilized before they expire at the end of the 15-year carryforward window.1
4. Monitor the Commissioner’s Rates: Stay abreast of annual announcements regarding the 2028+ refundability rates, as these will be subject to the $25 million statewide cap.4

The Minnesota Credit for Increasing Research Activities remains one of the state’s most powerful economic engines. Through the disciplined application of the rules surrounding Schedule RD, businesses can significantly lower their effective tax rate and gain a competitive edge in an increasingly innovation-driven global marketplace.3

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