On April 2, the Michigan Department of Treasury published guidance (Notice Regarding New Research and Development Credit) on the state’s new tax credit for eligible research and development (R&D) expenses and confirmed that it plans to issue a revenue administrative bulletin on the topic.
The guidance follows the January enactment of two bills (House Bills 5100 (Public Act 186 of 2024) and 5101 (Public Act 187 of 2024)) that together created the R&D credit (see our related Alert for high-level provisions and some history on Michigan R&D credits).
Application and Administration
The refundable credit applies to R&D activities beginning January 1, 2025, regardless of the taxpayer’s year-end.
- The guidance specifies that for R&D expenses incurred during the 2025 calendar year, all claimants with tax years beginning in 2025, including calendar- and fiscal-year corporate income tax (CIT) payers and flow-through entities, must submit their tentative claims no later than April 1, 2026.
- A tentative claim must be timely filed to claim the R&D credit, and Treasury will not accept tentative claims after the statutory deadline. Because tentative claims will be used in any required proration calculation, they should be made using actual — not estimated — expenses.
If the total amount of tentative claims exceeds the credit limit, Treasury must notify businesses of the adjustment. Neither HB 5100 nor HB 5101 specified when or how Treasury must provide that information.
- The guidance states that Treasury will publish a general notice on its website notifying taxpayers whether adjustments to tentative claims are required for the calendar year and any amounts thereof. That notice will specify “whether proration is required for each type of claimant and will not contain taxpayer-specific information” [emphasis added]. According to the guidance, Treasury anticipates publishing the general notice before the annual return deadline for CIT filers (that is, April 30).
Once Treasury has published the notice, taxpayers will be eligible to claim the credit, adjusted as necessary, on their annual returns filed after the end of their tax years.
Qualifying R&D Expenses
Qualifying R&D expenses are those expenses defined in Internal Revenue Code Section 41(b) but incurred in Michigan.
- The guidance confirms that the new credit looks only to IRC Section 41, noting that in determining their state credits, taxpayers should not apply any IRC provisions, federal regulations, or federal concepts other than those that may be applicable under the Michigan Income Tax Act.
Qualifying expenses are calculated per calendar year regardless of the taxpayer’s tax year-end.
- The guidance clarifies that Treasury will develop an optional method for fiscal-year filers to convert their fiscal-year R&D expenses into calendar-year expenses for base-amount years before 2025. Additional information about that method will be published in future Treasury guidance.
Credit Amounts and Limits
The bills generally define an authorized business as a specified taxpayer that has incurred qualifying R&D expenses over the base amount during the calendar year ending with or during the tax year for which a credit is being claimed. Only authorized businesses with R&D expenses exceeding the base amount during a calendar year will be eligible for a credit in that year.
The base amount is defined as the average annual amount of qualifying R&D expenses incurred during the three calendar years immediately preceding the calendar year ending with or during the tax year for which a credit is being claimed. If an authorized business did not have previously qualifying R&D expenses, it has a base amount of zero. If an authorized business did not have qualifying R&D expenses in the three immediately preceding calendar years, the average annual amount is based on the number of calendar years during which the business incurred qualifying R&D expenses.
Qualifying taxpayers with at least 250 employees are eligible for a credit of 3% on expenses up to the base amount and 10% on excess expenses, with a maximum credit of $2 million per year. Qualifying taxpayers with fewer than 250 employees are eligible for a credit of 3% on expenses up to the base amount and 15% on excess expenses, with a maximum credit of $250,000 per year.
- The guidance indicates that Treasury plans to explain how to count the number of employees for the unadjusted credit calculation. It notes that MCL Section 206.605(3) defines an employee as “an employee as defined in [IRC] Section 3401(c)…. A person from whom an employer is required to withhold for federal income tax purposes is prima facie considered an employee.”
The maximum amount of credit available across all authorized businesses per calendar year is $100 million. If total refund claims exceed that, the amount of credit allowed will be prorated across all taxpayers that applied for the credit using the applicable method provided in the bills.
Provisions for Corporations and Flow-Throughs
Corporate Entities
For corporate purposes, a taxpayer is a corporation or unitary business group (see MCL Section 206.611(5)).
- The guidance confirms a CIT payer that is a unitary business group would make all calculations (e.g., number of employees, total expenses, base amount, maximum credit amount, and any applicable proration) at the group level.
Flow-Through Entities
To be an eligible flow-through entity, the entity must be subject to Michigan income tax withholding on employees and, for the tax year, must not be a disregarded entity, taxed as a C corporation for federal income tax purposes, or subject to the Michigan Business Tax (MBT) Act. An eligible flow-through entity will take the credit on its annual withholding return for the tax year in which its tentative claim was filed.
- The guidance provides some favorable relief for flow-through entities related to periodic withholding payments, allowing for a reduction once the tentative claim adjustment notice is published.
To illustrate that point, the guidance provides an example using R&D expenses incurred in calendar year 2025. It says a flow-through entity filing a withholding tax return would claim the credit with its 2026 withholding tax return (due February 28, 2027) and could begin to reduce its 2026 periodic withholding payments as soon as Treasury issues its tentative claim adjustment notice for 2025 expenses.
The credit is allowable only for flow-through entities and may not be passed on to owners.
BDO Insights
- Unlike the federal credit (and credits in most states), the measure of qualifying R&D expenses is made on a calendar-year basis for all taxpayers, regardless of tax year-end. Thus, authorized businesses with fiscal year-ends will require some additional analysis.
- The guidance says Treasury anticipates publishing any required proration, allowing taxpayers to claim the credit, by April 30. However, given the uncertainty, corporate taxpayers that have timely filed might want to extend their return due dates to avoid having to file amended returns to claim refunds.
- The new credit includes unusual treatment of taxpayers that have little or no R&D expenses. If a taxpayer had no R&D expenses in the last three years, the legislation states that the base amount is zero. If, for example, a taxpayer had R&D expenses in only one year during the base period (e.g., $100,000 in 2024), then the legislation states that the expenses in the single year will be the taxpayer’s base amount (e.g., $100,000) instead of taking an average of the last three years (e.g., $0 + $0 + $100,000 / 3). That unusual approach seems to be a drafting error, with the drafter possibly imagining a situation in which a taxpayer was not in existence for the three years in the base period. If the taxpayer did not exist throughout the base period, then it would be appropriate to divide by the number of years of existence. If the taxpayer existed for the last three years, then it is counterintuitive that the taxpayer would not get to divide its R&D expenses for the last three years by three.
- While the guidance confirms that taxpayer names and credit amounts will be included on a report to the legislature and governor, it also specifically mentions that the published adjusted credit notice will not contain taxpayer-specific information, providing some clarity on public release of details by taxpayer.
- Because the credit is available only on a CIT return for corporations, and the statute for flow-through entities specifically excludes those filing under the MBT Act, no taxpayers filing the MBT because of a certificated credit election are eligible for the new R&D credit.
- Even if a federal R&D credit has not previously been claimed, taxpayers should consider re-evaluating the potential benefit available related to their R&D activities in Michigan, especially given the credit’s refundable nature.
- Additional Treasury guidance is expected in the form of a revenue administrative bulletin, as well as forms and instructions for administering the new credit.
Please visit BDO’s State & Local Tax Services and state R&D tax credits pages for more information on how BDO can help.