Michigan enacts state-level R&D tax credit

Businesses that qualify to claim the federal tax credit for increasing research activities (R&D credit) will be able to claim a credit against Michigan taxes for qualifying expenses incurred for research conducted in the state effective for tax years beginning on or after Jan. 1, 2025. In an effort to reposition Michigan as a leader in research and innovation, House Bills 5100 (Public Act 186 of 2024) and 5101 (Public Act 187 of 2024) reestablish a Michigan R&D tax credit. The credit is available to corporations and pass-through entities and will be subject to limitations based on the total number of employees at the business. Here’s an overview of this new tax incentive.

Key terms based on federal R&D credit rules

The Michigan law looks to the Internal Revenue Code (IRC) to decide which expenditures qualify for the credit. Here’s a quick review of the federal rules. The first step is to determine if the activity in question meets the IRC definition of R&D, which is based on four criteria:

• Is the activity intended to develop a new product or process or to improve the function, performance, reliability, and/or quality of a product or process? 
• Is there technical uncertainty involved — is it even possible to develop and/or improve the product or process in question? If it’s possible, is there uncertainty related to the appropriate design or method used to develop the product or process?
• Is experimentation required? The uncertainty involved must lead to testing or analysis that evaluates alternatives.
• Is the activity technological in nature and based in science, such as biology, chemistry, computer science, or engineering?

If the activity meets the criteria to qualify as R&D, the following three categories of expenses will qualify for the credit:

• Wages for any employee directly performing, supporting, or supervising the R&D activities.
• Supplies used in the process of experimentation, such as prototypes or raw materials.
• Expenditures for rental of off-site and cloud-based server space for design or testing of new or improved software.
• Expenses associated with outside service providers used during the research process, including contract engineers, consultants, developers, outside lab testing, and the like.

Once the qualified expenses are determined for the year, they’re compared to a federal “base amount,” which is the average spent on those activities over the last three years. If the amount spent in the current year is more than half of the three-year average, the taxpayer generates a federal credit.

Calculating the Michigan R&D credit

Once a business calculates its federal R&D credit, the next step is to identify the qualifying expenses that were incurred to conduct research in Michigan. The process involves calculating the current-year Michigan-based expenses as well as a Michigan-specific base amount. Taxpayers can claim a credit for those Michigan expenses as follows:

• Large taxpayers (250+ total employees) can claim a credit amount equal to 3% of qualifying expenses up to the base amount plus 10% on expenses in excess of the base amount. The maximum credit available to these taxpayers will be $2 million per year.
• Small taxpayers (<250 total employees) can claim a credit amount equal to 3% of qualifying expenses up to the base amount plus 15% on expenses in excess of the base amount. The maximum credit available to these taxpayers will be $250,000 per year.

Both large and small taxpayers can claim an additional 5% credit by incurring qualifying expenses for research performed in collaboration with an eligible Michigan research university, up to a maximum additional credit of $200,000 per year.

Michigan credits also have potential to be refundable if the taxpayer hasn’t met the annual credit cap and only if all other nonrefundable credits have been fully utilized.

Administrative processes for claiming Michigan’s R&D credit

Taxpayers who want to claim the R&D credit for 2025 must file an application with the Michigan Department of Treasury before April 1, 2026. For credits claimed in subsequent years, that deadline will move up to March 15. The application form is separate from the business tax return, and it serves to notify the state of the total claims expected for the year.

That advance notification is important because statewide the total Michigan R&D credits amount that all taxpayers can claim is capped at:

• $75,000,000 for large taxpayers.
• $25,000,000 for small taxpayers.

If the total credits applied for by all taxpayers statewide exceed the capped amounts above, all credits will be awarded to taxpayers on a pro rata basis, and the department would notify taxpayers via its website regarding any adjustments to their claims. Unused credits that exceed the amount awarded to a taxpayer in a given year may not be carried back or forward for use in a different tax year.

Start planning now to track qualifying Michigan R&D expenses

With the new credit available for expenditures in the current calendar year, it’s a good idea to begin working with a tax advisor as soon as possible on modifications to R&D expense tracking systems that will help identify Michigan-specific costs, as well as any of those costs that relate to collaboration with Michigan research universities. Because the base amount needed to determine the amount of the 2025 credit requires calculation of Michigan-based R&D expenditures in the previous three years, taxpayers may need to apply the modifications to their R&D calculations for several years prior to 2025.

Longer term, this new incentive points to a new economic strategy in Michigan, one that seeks to incentivize taxpayers to evaluate the potential benefit of moving R&D activities from other states into Michigan, and with the goal of factoring it into cost-benefit decisions when weighing where new R&D facilities will be built and where new high-tech and high-paying jobs will be offered.