Minnesota’s R&D tax credit: the best tool you’ve never heard of

Lost in the Minnesota jobs bills that passed in April is a gem whose importance rivals the angel investment tax credit — an R&D tax credit for the first 10 percent of up to $2 million of qualified research and development expenses, and 2.5 percent for costs above $2 million.

There’s little doubt that Minnesota’s  historic $60 million angel investment tax credit has received the lion’s share of publicity, especially from this publication.

But lost in the same jobs bills that passed in April is a gem whose importance rivals or even exceeds the angel credit.

Beginning in 2011, companies can receive a tax credit for the first 10 percent of up to $2 million of qualified research and development expenses, and 2.5 percent for costs above $2 million. The old credit allowed five percent and two percent, respectively.

In a way, the R&D tax credit expansion was long overdue. Minnesota was the first state in the country to pass an R&D credit in 1981. But as GOP gubernatorial nominee Tom Emmer noted in his economic platform, several states have surpassed Minnesota over the last 30 years.

For example, Wisconsin offers a five percent credit on amounts above $2 million.

Minnesota’s new-and-improved R&D credit stands out for a number of reasons. First, more companies can use it. The old law applied only to C corporations — mostly large companies — whereas  S corporations, partnerships and individuals now can claim the credit.

That’s a big change because 90 percent of the $7 billion in federal R&D tax credits each year are claimed by Fortune 1000 companies, said Scott Schmidt, principal of Black Line Group in Plymouth, Minnesota, a firm that advises businesses on the R&D credit.

“A lot of small businesses are not taking advantage of the credit,” Schmidt said. (More on that later)

That’s a shame because the tax credits can significantly boost cash flow, especially for emerging and startup companies who lack the financial cushion of a Medtronic or 3M.

Secondly, and even more cool, Minnesota’s R&D credits are refundable. That means even if the credits reduce a company’s tax bill to zero, the state still will cut the business a check for the remaining value of credits still owed. To the best of Schmidt’s knowledge, only three other states offer such a credit.

“It’s a phenomenal opportunity with the enhancements to the state tax credit,” Schmidt said.

But as we said before, only large companies tend to claim the credit. Part of the reason is that smaller businesses are either unaware of the credit or think they don’t qualify because of the credit’s vague language.

“It’s as murky of a tax credit there is,” Schmidt said.

So here are five tips to the credit, courtesy of Schmidt’s presentation to a recent MOJO Minnesota gathering at the University of Minnesota:

Not just mad scientists toiling away in labs

The credit applies to all aspects of R&D at a company, but it’s mostly for compensation to people who not only conduct the research but supervise and support it, such as outside contractors,  lawyers and engineers.

A medical device firm, for instance, could claim a credit for the money it pays a contract manufacturer that make its prototypes or a lab that tests its devices. It also could receive a credit for fees it pays to intellectual property lawyers to obtain a patent, even if they’re unsuccessful.

Failure is good

By definition, R&D involves experimentation, which means some things are going to work and some things aren’t. Either way, a company still receives the credit, so why not push the boundaries? The idea of the credit is to mitigate the costs of failure and reward companies that take risk.

The better-burning light bulb

Don’t feel that you have to invent nuclear fusion or space warp drives. The credit applies to smaller goals like boosting the quality of an existing product or reducing the cost to make it.

The research “does not need to be revolutionary,” Schmidt said. “It can be more incremental improvements so companies can continue to be more competitive on a global basis.”

Social sciences/equipment purchases need not apply

The credit applies to only “hard sciences,” like biology, chemistry, mechanical engineering and computer science.

You can’t receive the credit for large capital purchases because the assets depreciate. However, a company could claim the credit for the time it takes to train people to use the equipment.

No application

Unlike the angel program, the state does not need to certify a company before it awards credits. A company can claim the credits on its regular tax forms.