The Definitive Guide to the New or Improved Business Component Under the Nebraska Research and Development Tax Credit

A business component is defined as any product, process, computer software, technique, formula, or invention held for sale, lease, or license, or used by the taxpayer in a trade or business. For a component to be considered new or improved, the research activities must be intended to enhance its functionality, performance, reliability, or quality through a systematic process of experimentation. 1

The concept of a new or improved business component serves as the foundational pillar of the Nebraska Advantage Research and Development Act. By anchoring state-level tax incentives to the rigorous standards of Internal Revenue Code (IRC) Section 41 and Section 174, Nebraska has created a robust mechanism for fostering industrial and technological growth. This alignment ensures that businesses operating within the state can navigate a familiar federal framework while benefiting from a credit that is, in many instances, fully refundable at the entity level. The state’s commitment to this incentive was underscored by the passage of Legislative Bill 727, which extended the sunset date for first-year claims to December 31, 2033, signaling a long-term policy goal of transforming the regional economy into a hub for high-tech manufacturing, bio-sciences, and specialized agriculture. 3 To successfully claim these benefits, taxpayers must move beyond a superficial understanding of innovation and instead master the technicalities of the four-part test, the “shrink-back” rule, and the specific documentation requirements mandated by the Nebraska Department of Revenue. 4

The Statutory Integration of Nebraska Law and Federal Tax Code

The Nebraska Research and Development Tax Credit is not a standalone definition of innovative activity; rather, it is a statutory mirror of federal law designed to simplify compliance for multi-state entities. Under Nebraska Revised Statute § 77-5803, the state allows a credit for business firms making expenditures in research and experimental activities as defined in Section 174 of the Internal Revenue Code. 7 This explicit linkage means that any evolution in federal tax law—such as the transition from immediate expensing to mandatory amortization of research costs under the Tax Cuts and Jobs Act (TCJA)—directly impacts the calculation and eligibility of Nebraska credits.

The Foundational Role of IRC Section 174 and Section 41

The Nebraska framework relies on two distinct but interrelated sections of the federal tax code to define the scope of a new or improved business component. Section 174 focuses on the nature of the expenditures, defining “research and experimental expenditures” as those incurred in connection with the taxpayer’s trade or business which represent research and development costs in the experimental or laboratory sense. 8 This section serves as the broad gateway, identifying the types of costs—such as wages, supplies, and contract research—that are eligible for consideration.

Conversely, Section 41 provides the specific criteria for the credit itself, introducing the concepts of the “Qualified Research Activity” (QRA) and the “Qualified Research Expense” (QRE). In the context of the Nebraska credit, the business component is the literal object of the research. The law requires that the research be undertaken for the purpose of discovering information which is technological in nature and the application of which is intended to be useful in the development of a new or improved business component of the taxpayer. 2 This creates a high evidentiary bar; the taxpayer must prove not only that they invested in “technical” labor, but that the work was directed at a specific, identifiable component of their business operations.

Legislative Resilience and the 2033 Extension

The Nebraska Legislature has remained proactive in modifying these incentives to ensure the state remains competitive with regional neighbors like Iowa, Kansas, and Missouri. Legislative Bill 727, which became operative in 2023, represents the most significant recent expansion of the program. It pushed the window for businesses to first claim the credit from 2022 to December 31, 2033. 3 This extension provides a ten-year horizon of stability for capital-intensive industries that require long lead times for product development.

Furthermore, the introduction of the One Big Beautiful Bill Act of 2025 (OBBBA) at the federal level has introduced new complexities regarding retroactive expensing for tax years 2022-2024. 9 Because Nebraska’s credit is tied to the federal allowance, the state’s revenue office must provide guidance on how retroactive federal elections affect previously filed Nebraska returns. This interplay highlights the necessity of maintaining a “dynamic” compliance strategy that accounts for both Lincoln and Washington D.C. legislative shifts.

Deconstructing the Six Categories of Business Components

To qualify for the Nebraska credit, a taxpayer must identify the specific “business component” being developed or improved. The Nebraska Department of Revenue adheres to the six categories recognized under federal Treasury Regulations. These categories define the scope of what can be considered “new or improved” and serve as the starting point for any audit defense. 2

Products and Inventions

In the manufacturing and agricultural sectors dominant in Nebraska, the most common business component is a physical product. An “invention” is a specialized subset of a product that represents a novel, patentable solution to a technical problem. 2 For a product to be considered “new or improved,” the taxpayer must demonstrate that the research was aimed at the product’s functional characteristics. Aesthetic changes—such as a new ergonomic grip for a hand tool that does not change its performance, or a new color scheme for a commercial tractor—are explicitly excluded from the definition of a “permitted purpose.” 2 The focus must remain on the mechanics, durability, and operational efficiency of the physical item.

Processes and Techniques

Research in Nebraska often focuses not on the final item being produced, but on the method of production. A “process” refers to the sequence of steps used to produce a result. For a Nebraska-based manufacturing facility, a new robotic assembly sequence designed to reduce material waste or increase cycle time would be a business component. 5 Similarly, a “technique” refers to a specialized method of performing an action. An agricultural firm developing a proprietary method for applying nitrogen to soil to maximize uptake while minimizing environmental runoff is developing a “technique” business component. 5 The improvement here is measured by the efficiency, speed, or quality of the output generated by the process or technique.

Computer Software

Software components have become increasingly vital to the Nebraska economy. Software can be developed for sale, lease, or license (Commercial Software) or for internal use (Internal Use Software). The standards for Internal Use Software (IUS) are generally higher, requiring the software to be innovative, involve significant economic risk, and not be commercially available. 10 For the Nebraska credit, software that manages a production process or provides a new, technically advanced interface for a customer often qualifies as an improved business component. The “improvement” typically involves optimizing algorithms, enhancing data processing speeds, or solving complex integration challenges between disparate hardware systems. 15

Formulas

Common in the biotech and food processing industries, a “formula” is a specific chemical or ingredient composition. When a Nebraska-based food manufacturer experiments with different enzyme combinations to increase the shelf life of a dairy product without using synthetic preservatives, each iteration of the enzyme mix represents an attempt to improve a formula business component. 4 The “new or improved” metric in this category is often tied to stability, safety, and functional performance under varying environmental conditions. 11

The Four-Part Test: The Gateway to Qualification

The Nebraska Department of Revenue applies the federal “Four-Part Test” to determine if the activities related to a business component qualify for the tax credit. This test must be satisfied for every individual business component for which a credit is claimed. 4

1. The Section 174 / Elimination of Uncertainty Test

The primary threshold for qualification is the existence of technical uncertainty. Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the business component, or the appropriate design of the component. 10 Capability uncertainty addresses whether the project is even possible. Methodology uncertainty addresses the “how” of the project. Design uncertainty—the most common form—addresses what the specific configuration of the product or process should be to achieve the desired result. 5

2. The Technological in Nature Test

The research must fundamentally rely on the principles of the “hard” sciences. This includes physical sciences (chemistry, physics), biological sciences (agronomy, biology), engineering, or computer science. 4 Nebraska law explicitly excludes research in the social sciences, arts, or humanities. Therefore, market research, consumer surveys, and management studies do not meet this threshold, even if they result in a more successful business outcome. The “new or improved” aspect must be rooted in scientific or engineering principles. 2

3. The Permitted Purpose Test

This is where the “New or Improved” requirement is functionally codified. The research must be intended to improve the functionality, performance, reliability, or quality of the business component. 1 If the research is aimed at any of these four pillars, it is a permitted purpose. If the research is aimed at style, taste, or cosmetic appeal, it is disqualified. For example, developing a more durable alloy for a wind turbine blade (reliability) is a permitted purpose; painting that same blade a new shade of green for branding purposes is not. 2

4. The Process of Experimentation Test

Finally, the taxpayer must demonstrate that substantially all of the activities constitute a process of experimentation. This involves identifying the technical uncertainty, developing one or more hypotheses, and conducting a systematic evaluation of alternatives through modeling, simulation, or systematic trial and error. 5 In Nebraska, this requires documentation that shows the taxpayer did more than just “fix” a broken machine; they systematically explored various technical paths to find the optimal solution. The process must be iterative, involving the testing of prototypes and the refinement of designs based on technical data. 5

Understanding the “Shrink-Back” Rule in Nebraska Audits

A critical concept for Nebraska taxpayers, particularly those in the manufacturing and software sectors, is the “shrink-back rule.” This rule provides that if a taxpayer fails the four-part test at the level of the overall product or system, they may “shrink back” the analysis to the next discrete sub-component. 17 If the sub-component meets the four-part test, then the expenses associated with that sub-component qualify for the credit, even if the larger system does not.

Consider a Nebraska-based manufacturer of commercial irrigation systems. If the overall system fails the technological in nature test because it consists primarily of off-the-shelf piping and pumps, the manufacturer can “shrink back” to a proprietary new control valve they designed. If that specific valve was developed through a process of experimentation to improve water-flow precision (functionality), the costs associated with the valve’s development qualify for the Nebraska credit. This rule prevents the disqualification of entire claims due to the inclusion of some routine components. 13

Nebraska Revenue Office Guidance and Administrative Framework

The Nebraska Department of Revenue (DOR) provides administrative clarity through General Information Letters (GILs), Revenue Rulings, and detailed form instructions. The Nebraska credit is primarily a percentage-based calculation derived from the federal credit, which simplifies the process for businesses that already track their research expenditures for federal purposes. 13

Claiming the Credit: Form 3800N and Worksheet RD

To claim the Nebraska Research Tax Credit, a business firm must complete Form 3800N (Nebraska Incentives Credit Computation) and the accompanying Worksheet RD (Research Tax Credit Worksheet). 5 Unlike other incentive programs, there is no requirement to submit an application or register prior to claiming the credit. The completed forms are filed with the business’s income tax return for the year in which the expenditures were made. 6

The calculation process follows a defined sequence:

1. Federal Benchmark: Determine the total federal research credit allowed using IRS Form 6765. 13
2. State Apportionment: For multi-state businesses, the credit must be restricted to activities performed within Nebraska. This is done using either a property/payroll factor or an actual expenditure ratio. 4
3. Application of Rate: Apply the 15% rate for standard off-campus research or the 35% rate for research conducted at a Nebraska university or a university-owned facility. 13

The E-Verify Requirement: A Critical Compliance Mandate

A unique and non-negotiable requirement of the Nebraska Advantage Research and Development Act is the E-Verify mandate. Since October 1, 2009, any business firm claiming the tax credit must timely and electronically verify the work eligibility status of all employees hired in Nebraska during the tax year for which the credit is claimed. 6

The Nebraska DOR views this as a condition of eligibility, not merely a reporting obligation. Failure to verify even a single new hire through the federal E-Verify system can lead to the total disallowance of the credit for that tax year. 13 Taxpayers must maintain E-Verify logs for a minimum of four years to satisfy audit requirements. This mandate underscores the state’s policy of ensuring that tax-subsidized innovation supports a legally authorized workforce. 13

The 35% Enhanced University Research Credit

To encourage collaboration between the private sector and higher education, Nebraska offers an enhanced 35% credit rate for research conducted on the campus of a Nebraska college or university. 7 Revenue Ruling 29-10-2 clarifies that “college or university” refers to an institution of higher learning offering courses resulting in a degree. 19

The location of the research is the deciding factor for this higher rate. A business can qualify for both the 15% and 35% rates in the same year if they conduct in-house research at their own facility (15%) and contracted research on a university campus (35%). The enhanced credit is available for the first year it is claimed and for the four following tax years, provided the business continues to earn the federal credit and continues the university collaboration. 5

Case Study in Agricultural Innovation: The Pecan Aspirator System

To illustrate the practical application of the “New or Improved Business Component” definition, we can examine a case study involving Nut & Co., a Nebraska-based manufacturer of agricultural processing equipment. 5

Identifying the Technical Challenge

Nut & Co. identified a significant problem in the commercial pecan shelling industry. Existing methods relied on high-pressure blowers to separate pecan meat from the shells. This blowing method was inefficient, as it often failed to separate heavier shell fragments, and it created a hazardous, dust-filled environment for workers. 5

Defining the Business Component

The “business component” in this scenario was the “Pecan Aspirator System”—a new machine intended for sale to commercial shellers. The project objective was to develop a suction-based extraction method that would improve the “performance” and “quality” of the shelling process. 5

Satisfying the Four-Part Test

1. Elimination of Uncertainty: At the project’s inception, Nut & Co. did not know if a suction method could provide sufficient force to separate shells without damaging the pecan meat. They also faced uncertainty regarding the “design” of the internal baffles and the “method” of maintaining consistent vacuum pressure. 5
2. Technological in Nature: The development process relied on mechanical engineering and the principles of fluid dynamics (suction and airflow). The team tested various materials, ultimately choosing stainless steel and specialized galvanized piping to ensure the system could withstand the abrasive nature of shell fragments. 5
3. Permitted Purpose: The goal was to create a “new” function (suction-based extraction) that would lead to “improved” performance (higher purity of pecan meat) and “improved” quality (cleaner work environment). 5
4. Process of Experimentation: Nut & Co. built several prototypes. They conducted iterative “trial and error” testing, adjusting the vacuum motor speeds and the angle of the intake chutes. They documented the separation efficiency of each configuration, which allowed them to refine the design into a commercially viable product. 5

Outcome and Credit Realization

Because the Pecan Aspirator System met all four criteria, Nut & Co. was able to qualify the wages of the engineers, the cost of the prototype materials (supplies), and the time spent by shop workers in the testing phase. These expenses formed the basis of their federal R&D credit, and they subsequently claimed a 15% refundable credit on their Nebraska tax return, providing the liquidity needed to bring the product to market. 4

Multi-State Apportionment and Calculation Methods

For companies with operations both within and outside of Nebraska, the state requires a precise method of apportionment to ensure the credit only subsidizes in-state activity. Taxpayers have two primary methods for this calculation. 7

Method I: Property and Payroll Factors

This method uses the average of the Nebraska property factor and the Nebraska payroll factor. The property factor is the ratio of the average value of the taxpayer’s real and tangible personal property in Nebraska to the total everywhere. The payroll factor is the ratio of compensation paid in Nebraska to total compensation. 18

$$\text{Nebraska Factor} = \frac{\text{Property Factor} + \text{Payroll Factor}}{2}$$

The resulting percentage is multiplied by the total federal credit to determine the Nebraska share. This method is often beneficial for companies with significant physical infrastructure and a large, stable workforce in the state. 18

Method II: Actual Expenditure Ratio

Alternatively, a taxpayer can use the ratio of actual research expenditures in Nebraska to total research expenditures everywhere. 7

$$\text{Expenditure Ratio} = \frac{\text{Qualified Research Expenses in Nebraska}}{\text{Total Qualified Research Expenses Everywhere}}$$

This method is generally preferred by high-tech startups or software companies that may have a high concentration of R&D personnel in Nebraska but fewer physical assets. It provides a more direct link between the innovation activity and the tax benefit. 7

Statistical Overview of Program Performance

The Nebraska Advantage Research and Development Act has been a significant driver of high-wage job growth and private sector investment. A 2022 performance audit provides a detailed look at the program’s impact from 2006 to 2020. 21

The data indicates that while the high-tech sector accounts for a quarter of the participants, the remaining 76% of awards go to traditional industries like manufacturing and agriculture that are innovating within their existing fields. 21 This suggests that the “new or improved business component” definition is being successfully applied by non-traditional tech firms to modernize Nebraska’s core industries.

Intersection with the ImagiNE Nebraska Act

It is critical for tax planners to understand how the R&D tax credit interacts with the ImagiNE Nebraska Act, which replaced the Nebraska Advantage Act in 2021. While both programs aim to stimulate growth, they operate under different mechanisms and satisfy different corporate needs. 22

The Nebraska Research Tax Credit is an annual, ongoing incentive. It requires no prior application and has no minimum investment or hiring threshold. It is focused purely on the technical nature of the work. 6

In contrast, the ImagiNE Nebraska Act is a project-based program. It requires a formal application, a fee ranging from $1,000 to $10,000, and a commitment to meet specific investment and job creation levels (e.g., $1 million investment and 10 new jobs for Tier 1). 22 Many Nebraska firms use a “layered” approach: they use ImagiNE for the capital expansion of a facility and the R&D credit to offset the ongoing costs of the engineering and scientific teams working within that facility. 21

Audit Preparedness and Documentation Strategy

Because the Nebraska R&D credit is often refundable, it is a high-priority item for DOR auditors. The “business component” is frequently the primary point of contention. To survive an audit, a company must move beyond high-level summaries and provide project-level substantiation. 16

Establishing a “NEXUS”

The IRS and Nebraska DOR require a clear “nexus” between the expenses claimed and the qualified research activity. This means that a lump-sum payroll entry for “Engineers” is insufficient. The company must be able to show which specific engineer worked on which specific business component, and what technical challenges they were trying to solve. 12

Record-Keeping Best Practices

1. Contemporaneous Narratives: Documentation should be created during the development process, not months later during tax season. This includes design meeting minutes, test logs, and failed prototype photos. 16
2. Project-Based Accounting: Use time-tracking software (e.g., Jira, Azure DevOps) to tag hours to specific business components. This creates a defensible audit trail that links labor costs directly to the “Process of Experimentation.” 16
3. Technical Benchmarks: Document the “baseline” performance of the business component before the research began. This makes the “improvement” in functionality or reliability quantifiable and harder for an auditor to dismiss as routine maintenance. 5
4. E-Verify Compliance: Maintain a spreadsheet showing the hire date and E-Verify confirmation number for every Nebraska employee. This is the first document an auditor will likely request. 13

Conclusion: The Strategic Value of the Nebraska R&D Framework

The “New or Improved Business Component” is more than a tax definition; it is a strategic blueprint for Nebraska companies to remain competitive in a global economy. By adhering to the rigorous Four-Part Test and ensuring meticulous documentation of their technical activities, businesses can significantly reduce their effective tax rate and improve their cash flow through refundable credits. The 2033 extension of the Nebraska Advantage Research and Development Act provides a stable, long-term environment for innovation, particularly for the state’s manufacturing and agricultural pillars. As the regional economy continues to evolve, the ability to leverage these incentives will distinguish the market leaders from the laggards. For the professional peer, the message is clear: the path to Nebraska tax efficiency is paved with well-documented, science-based improvements to discrete business components. 3

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