How to Claim the Massachusetts Research Credit

The Massachusetts Research Credit is a tax-based incentive available to businesses engaging in research and development activities within the Commonwealth. Its purpose is to encourage innovation by helping to offset research costs. This credit is calculated based on specific expenditures related to these research activities, and companies can leverage it to reduce their corporate excise tax.

Determining Eligibility for the Credit

Eligibility for the Massachusetts Research Credit rests on two elements: the type of business entity and the nature of the research. The credit is available to C corporations and S corporations. However, an S corporation cannot pass the credit through to its shareholders; it can only be applied against the S corporation’s own excise tax liability.

The core of eligibility lies in the research satisfying a “Four-Part Test,” which mirrors federal requirements under Internal Revenue Code (IRC) Section 41. The first part is the permitted purpose test, which requires that the research must be undertaken to create a new or improved business component. This component can be a product, process, computer software, or invention the taxpayer intends to hold for sale, lease, license, or use in their business.

A second requirement is the technological in nature test, meaning the research process must rely on principles of the physical or biological sciences, engineering, or computer science. This excludes research in areas like the social sciences or arts. For example, developing a new chemical compound for a manufacturing process would qualify, whereas conducting market research would not.

The third part of the test is the process of experimentation. This stipulates that the taxpayer must engage in a systematic process designed to evaluate one or more alternatives to achieve a result where the capability or method of achieving that result is uncertain at the outset. This often involves modeling, simulation, or a systematic trial and error methodology.

Finally, the fourth part of the test requires that the research be designed to discover information that would eliminate uncertainty concerning the capability or method for developing or improving a product or process. The uncertainty must relate to the technical ability to create the product or the appropriate design of that product, not its commercial success.

Identifying Qualified Research Expenses

Once a company confirms its research activities meet the four-part test, the next step is to identify the specific costs that can be included in the credit calculation. These are known as Qualified Research Expenses (QREs) and must be directly tied to research conducted within Massachusetts. The expenses fall into two primary categories: in-house research expenses and contract research expenses.

In-house research expenses consist of the wages paid to employees for performing qualified services and the cost of supplies used in the research process. Qualified services include engaging in the conduct of research, providing direct supervision, or offering direct support for research activities. The cost of supplies includes any tangible property, other than land or depreciable property, that is used and consumed in qualified research, such as materials for a prototype.

The other category is contract research expenses, which are costs paid to a third party to perform research on the taxpayer’s behalf. For these expenses to qualify, the taxpayer must retain substantial rights to the research results. Only 65% of the amount paid to the third party is considered a QRE, and the research must be performed within Massachusetts.

Calculating the Credit Amount

After identifying all Qualified Research Expenses (QREs), the credit is computed. Massachusetts provides two distinct methods for this calculation: the regular credit calculation and the alternative simplified credit (ASC) calculation. A business must choose one method, and that choice can have significant implications for the final credit amount.

The regular credit calculation is more complex. It yields a credit equal to 10% of the QREs for the taxable year that exceed a calculated “base amount,” plus 15% of any basic research payments made to qualified educational institutions. The base amount is calculated by multiplying the company’s “fixed-base percentage” by its average annual gross receipts for the four preceding tax years. The fixed-base percentage is a ratio of aggregate QREs to aggregate gross receipts for a specific historical period, such as 1984-1988.

Alternatively, businesses can elect the simplified credit calculation. The ASC is 10% of the taxpayer’s current-year QREs that exceed 50% of the average QREs for the three preceding taxable years. If a taxpayer had no qualified research expenses in any of the three preceding tax years, the credit is 5% of the current year’s qualified research expenses. This method avoids the need to calculate a fixed-base percentage, making it a more straightforward option.

The credit is subject to limitations. It is limited to 100% of the corporation’s first $25,000 of corporate excise tax liability plus 75% of the liability over that amount. The credit cannot reduce the corporation’s tax liability below the minimum tax of $456.

Claiming the Credit and Carryforward Rules

Once the credit amount is calculated, it must be claimed on the company’s state tax filing. The primary form for this purpose is Massachusetts Schedule RC, Research Credit. This schedule is where the taxpayer details the calculation of the credit and reports the total QREs for the year.

The final credit amount calculated on Schedule RC is then transferred to the main corporate excise return. For a C corporation, this is Form 355, and for an S corporation, it is Form 355S. The credit directly reduces the amount of tax owed, and supporting documentation for the QREs should be maintained for verification.

Massachusetts law includes provisions for carrying forward any portion of the research credit that cannot be used in the current tax year. Unused regular credit can be carried forward for up to 15 years. If any portion of the credit is disallowed because of the 75% limitation rule, that specific amount can be carried forward indefinitely.

A provision beneficial to certain life sciences companies allows a portion of the unused research credit to become refundable after a specified period. This allows these businesses to receive a cash payment from the state even if they do not have sufficient tax liability to absorb the credit.