The Permitted Purpose Standard in the Nebraska Advantage Research and Development Act: A Comprehensive Legal and Regulatory Analysis

The Permitted Purpose test requires that research activities be undertaken with the specific intent to discover information that improves the functionality, performance, reliability, or quality of a new or improved business component. Under Nebraska law, this standard serves as the primary technical gatekeeper for determining a business entity’s eligibility for refundable tax credits valued at 15% or 35% of the federal research credit. 1

The implementation of the Permitted Purpose standard within the Nebraska Advantage Research and Development Act represents a sophisticated alignment of state economic policy with federal scientific and engineering benchmarks. By tethering state incentives to Section 41 of the Internal Revenue Code, the Nebraska Legislature has established a framework where technical merit is the prerequisite for fiscal reward. This report explores the multi-layered definitions of what constitutes a “permitted purpose,” examines the administrative guidance issued by the Nebraska Department of Revenue, and analyzes the intersection of these technical requirements with mandatory state compliance protocols such as E-Verify. Through a detailed investigation of statutory language, revenue rulings, and audit findings, one can discern the critical role this test plays in distinguishing substantive innovation from routine commercial activity. 4

The Statutory Architecture of Nebraska Research Incentives

The Nebraska Advantage Research and Development Act was designed to incentivize businesses to locate and expand their research operations within the state by offering a performance-based credit. Unlike other components of the Nebraska Advantage Act, which often require complex applications and pre-approval of investment and employment tiers, the Research and Development (R&D) credit is generally accessible to any business firm that incurs qualified research and experimental expenditures in Nebraska. 1 The state’s primary goal is to foster a climate where high-tech and agricultural innovation can flourish, providing a refundable credit that serves both established corporations and pre-revenue startups. 7

The foundational authority for this credit is found in Nebraska Revised Statute § 77-5803. This statute establishes a two-tiered credit structure based on the location and nature of the research activities. The regular credit allows for a refund of 15% of the federal credit allowed under IRC § 41 for research conducted anywhere in the state. 3 Conversely, the enhanced credit of 35% is targeted toward fostering collaboration between the private sector and the state’s academic institutions, applying specifically to research conducted on the campus of a Nebraska college or university. 7 This legislative distinction highlights the state’s strategic interest in utilizing university infrastructure as a catalyst for private-sector growth. 10

Legislative Continuity and Extensions

While the broader Nebraska Advantage Act (LB 312) stopped accepting new applications in 2020 to make way for the ImagiNE Nebraska Act, the Research and Development provisions were maintained and extended. 12 In 2023, the Nebraska Legislature passed LB 491, which significantly extended the sunset date for the R&D credit. 16 Under this extension, the credit remains available for tax years beginning on or before December 31, 2033. 6 This long-term horizon provides the stability necessary for capital-intensive industries, such as biotechnology and advanced manufacturing, to commit to multi-year research cycles within the state. 7

Deep Analysis of the Permitted Purpose Standard

The Permitted Purpose test, often referred to as the “Functional Purpose” or “Business Component” test, is the second of four tests established by the Internal Revenue Service (IRS) and adopted by Nebraska to define qualified research. 6 Its primary function is to ensure that the research being conducted has a substantive, non-aesthetic objective. Under IRC § 41(d)(3), research is deemed to have a permitted purpose only if it relates to a new or improved function, performance, reliability, or quality of a business component. 19

The Four Pillars of Functionality

The technical interpretation of these four pillars—functionality, performance, reliability, and quality—defines the boundaries of the tax credit. Each pillar requires the taxpayer to demonstrate that the experimental activity was aimed at a specific technical improvement:

1. Functionality: This involves research intended to enable a business component to perform a new task or fulfill its existing tasks in a fundamentally different way. 18 For example, a Nebraska agricultural equipment manufacturer developing a new sensor-driven automated steering system for tractors is engaged in functional research because it adds a new capability to the existing machinery. 2
2. Performance: This metric focuses on the efficiency, speed, or capacity of the component. 21 In the context of Nebraska’s growing data center and fintech sectors, a company that develops a proprietary compression algorithm to reduce data latency is seeking a performance improvement. 18
3. Reliability: This relates to the consistency of a product’s operation over time and its resistance to failure under stress. 2 Research conducted to identify why a specific composite material in wind turbine blades fails under extreme weather conditions in rural Nebraska, followed by testing of alternative materials to extend the blade’s life, satisfies this pillar. 2
4. Quality: Quality improvements focus on the precision, durability, or adherence to rigorous specifications of the business component. 19 A manufacturer of medical devices in Lincoln that conducts experiments to reduce the variance in a valve’s manufacturing tolerance is pursuing a quality-based permitted purpose. 20

Non-Qualifying Purposes and Aesthetic Exclusions

The Permitted Purpose test explicitly excludes activities focused on style, taste, cosmetic, or seasonal design factors. 19 This is a common point of contention during audits conducted by the Nebraska Department of Revenue. If a business redesigns its consumer-facing software interface to be more visually appealing or “modern” without improving the underlying processing speed or security features, those activities do not meet the permitted purpose. 19 The distinction lies in whether the uncertainty being resolved is technological or merely stylistic. 20

Furthermore, the law excludes “research after commercial production,” “adaptation of existing business components,” and “duplication of existing business components” (reverse engineering). 17 These exclusions serve to prevent businesses from claiming the credit for routine troubleshooting, minor customization for a single client, or simply copying a competitor’s product. 17

The Business Component and the “Shrink-Back” Rule

The Permitted Purpose test must be applied at the level of the “business component.” 19 A business component is defined as any product, process, computer software, technique, formula, or invention that is held for sale, lease, or license, or used by the taxpayer in their own trade or business. 19

A critical nuance in both federal and Nebraska law is the “shrink-back” rule. 20 This rule dictates that the requirements of the four-part test are applied first at the level of the overall product or process. If the overall project does not meet the criteria—perhaps because some parts are routine—the test is then applied to the most significant subset of elements of that product or process. 20 This “shrinking back” continues until either a qualifying component is identified or it is determined that none of the activities qualify. 20 This ensures that even if a large-scale project includes non-qualifying marketing or stylistic work, the specific engineering or scientific breakthroughs hidden within the project can still generate credits. 20

State Revenue Office Guidance: Administrative Clarity

The Nebraska Department of Revenue (DOR) and the Department of Economic Development provide guidance that translates these high-level legal definitions into actionable filing instructions. The primary vehicle for claiming the credit is the Nebraska Incentives Credit Computation (Form 3800N) and the Research Tax Credit Worksheet (Worksheet RD). 1

Revenue Ruling 29-10-2: The Definition of Campus

One of the most consequential pieces of guidance issued by the Tax Commissioner is Revenue Ruling 29-10-2, which clarifies the “Enhanced” Research Tax Credit. 3 This ruling was necessary to prevent businesses from claiming the higher 35% rate for all corporate research simply by contracting a small portion of it to a university. 10

Key administrative conclusions from Revenue Ruling 29-10-2 include:

• Definition of Higher Learning: A “college or university” is defined as an institution that offers courses resulting in a bachelor’s, vocational, associate, technical, or professional degree. 10
• Location Sensitivity: The phrase “in this state” refers specifically to the location of the campus or facility where the research takes place. 10 It is the physical location of the experimental activity—not the home office of the university or the business—that determines eligibility for the enhanced credit. 10
• Segregation of Credits: Businesses are encouraged to separately track on-campus and off-campus research. 10 A firm can qualify for a 35% credit on its university-based activities while simultaneously claiming a 15% credit for its in-house, off-campus R&D work. 7
• Five-Year Earning Periods: The ruling clarifies that the standard 20-year earning period for the regular credit and the 4-year period for the enhanced credit operate independently. 1 A taxpayer may begin an enhanced credit period years after starting their regular credit period if they subsequently initiate a university partnership. 10

Worksheet RD Apportionment Methods

Worksheet RD provides two distinct methods for businesses to calculate the amount of their federal credit that is “Nebraska-sourced.” 25 The DOR allows taxpayers to select the method that results in the larger credit, provided they have the documentation to support it. 25

Mandatory Compliance: The E-Verify Nexus

A unique and rigid feature of the Nebraska R&D credit is its intersection with employment law. Since October 1, 2009, no business firm is allowed to claim the R&D credit unless it provides evidence that it has electronically verified the work eligibility status of all new employees hired in Nebraska during the tax year. 1

This requirement is not merely a formality; it is a statutory prerequisite for the credit’s approval. 4 The DOR mandates the use of E-Verify, a federal web-based system that compares information from an employee’s Form I-9 against Social Security Administration and Department of Homeland Security records. 1 In the context of the Permitted Purpose, this means that even if a business produces a revolutionary breakthrough, the associated wages of its engineers cannot be included in the credit calculation if those engineers were not processed through E-Verify within 90 days of their hire. 7 This legislative choice ensures that state-funded incentives are utilized only by firms maintaining a legal workforce. 1

Illustrative Case Study: Advanced Agricultural Engineering

To bridge the gap between abstract law and practical application, consider the case of a Nebraska-based firm, “Nut & Co.,” which sought to develop a revolutionary pecan shelling system. 2

Project Objective and Technological Uncertainty

The company identified a significant inefficiency in the traditional method of separating pecan meat from shells, which relied on blowing air to sort the materials. 2 This traditional method often resulted in high breakage of the nut halves, reducing the market value of the product. The project aimed to develop an “Aspirator System” that utilized a suction method to extract the meat more gently. 2

At the outset, the firm faced several technological uncertainties:

• Capability: It was unknown if a suction-based system could generate enough force to move shells without also damaging the delicate nut meat. 2
• Design: The optimal configuration of off-fall tanks, galvanized piping, and the type of stainless steel required to maintain efficiency and safety was undetermined. 2

Application of the Permitted Purpose Test

The project satisfied the Permitted Purpose test because its objectives were purely functional. 2 Specifically:

• Performance: The suction method was intended to increase the speed of the separation process. 2
• Quality: The primary goal was to improve the “meat-to-shell” ratio and maintain the physical integrity of the pecan halves, which directly relates to the quality of the business component. 2

Experimental Process

The company engaged in a systematic process of experimentation. They developed prototypes and conducted trials using different materials and air-flow configurations. 2 They analyzed the results, identified failures (such as clogs in the off-fall tanks), and adjusted the design accordingly. 2 Because these activities were undertaken for the purpose of technical improvement, all associated wages for the engineers, supplies used in the prototypes, and costs for third-party testing were eligible for the Nebraska R&D credit. 2

Economic Impact and Program Statistics

The Nebraska Advantage Research and Development Act has been a significant driver of investment in the state’s high-tech and manufacturing sectors. Legislative audit reports provide a clear picture of the program’s scale and effectiveness. 8

Between 2006 and 2020, 460 companies were awarded over $72.3 million in credits. 8 The program’s growth has outpaced initial legislative estimates; while the legislature originally projected an annual cost of $5 million, the actual usage exceeded $10 million annually by 2020. 8

Sector-Specific Credit Distribution (2006–2020)

Research indicates that the program is highly effective at retaining businesses. Approximately 89% of the companies that claimed the credit for activity beginning in 2016 or earlier are considered “sustained” companies, meaning they maintained operations in Nebraska for five years or more after their first claim. 8 In rural areas, the agriculture sector remains the largest beneficiary, while urban areas like Omaha and Lincoln see the highest concentration of credits in the professional, scientific, and technical services sectors. 26

Interaction with the ImagiNE Nebraska Act

The transition from the Nebraska Advantage Act to the ImagiNE Nebraska Act has introduced new terminology, but the fundamental mechanics of the R&D credit remain stable. Under the ImagiNE Nebraska program, credits are still earned based on location, investment, and wages, but the program emphasizes job growth and high-wage thresholds more aggressively. 14

For companies operating under the ImagiNE framework, the R&D credit can be used for a wider variety of “permitted purposes” related to business expansion, including:

• Nebraska Income Tax: Offsetting corporate or personal liability. 28
• Sales and Use Tax Refunds: Direct refunds for taxes paid on qualified property. 29
• Recruitment and Retention: Reimbursing costs for marketing, search firms, and even student loan repayment for new employees. 28
• Job Training: Funding the upskilling of workers at qualified locations. 28

This flexibility allows the R&D credit to function as a liquid asset for a business, supporting not just the lab work but the broader ecosystem of hiring and training necessary to bring a new technology to market. 27

Future Outlook: Legislative and Global Shifts

As of late 2025, two significant shifts are impacting the Nebraska R&D landscape: federal expensing rules and international trade restrictions.

Reinstatement of Domestic R&E Expensing (OBBBA 2025)

The federal One Big Beautiful Bill Act (OBBBA), signed in July 2025, reversed a major provision of the 2017 Tax Cuts and Jobs Act. 30 For tax years beginning after December 31, 2024, businesses can once again immediately expense domestic research and experimental costs under a new IRC Section 174A, rather than being forced to amortize them over five years. 30

This is a critical development for Nebraska taxpayers. Because the state credit is a percentage of the federal credit, and because the federal credit is calculated based on these expenditures, the return to immediate expensing simplifies the calculation and improves the immediate cash-flow benefit for innovators. 7 Small businesses with average annual gross receipts under $31 million may even elect to apply these expensing rules retroactively to the 2022-2024 period by amending their returns. 30

Foreign Adversarial Restrictions (LB 644)

At the state level, Nebraska has taken steps to ensure that its tax incentives do not benefit international rivals. Effective October 1, 2025, any “foreign adversarial company” is prohibited from receiving credits under the Nebraska Advantage Research and Development Act. 29 This restriction applies to entities owned or controlled by interests in countries such as China, Russia, Iran, and North Korea. 29 Applicants must now provide ownership disclosures to the Department of Economic Development, and non-compliance results in the total forfeiture of all tax reductions, exemptions, or refunds. 29

Audit Defense and Documentation Strategies

Given that the R&D credit is often claimed without prior state approval, the “audit” is the primary mechanism of enforcement. 1 To defend a claim based on the Permitted Purpose, a business must move beyond narrative descriptions and provide objective evidence. 2

Effective documentation strategies include:

• Project Charters: Documents created at the start of the project that explicitly state the “functional” goal (e.g., “Objective: Reduce fuel consumption by 15%”). 2
• Testing Logs: Raw data from experiments that show failed attempts, as failure is a key indicator that “uncertainty” existed. 2
• Personnel Interviews: Contemporary notes from lead engineers explaining the technological challenges they faced. 7
• Accounting Nexus: A clear link between a specific employee’s time (W-2 wages) and a specific qualifying project. 7

Taxpayers should also be aware of the “Substantially All” rule. 20 If at least 80% of an employee’s activities meet the four-part test, 100% of their wages can be included in the credit calculation. 20 Conversely, if less than 80% is qualifying, only the specific time spent on R&D can be included. 20 Careful time-tracking is therefore essential for maximizing the credit while maintaining audit readiness. 7

Conclusion

The meaning of Permitted Purpose in the context of the Nebraska Research and Development tax credit is rooted in the pursuit of technical functionality over aesthetic form. It is the legal standard that differentiates a “researcher” from a “designer” in the eyes of the tax code. By adopting the federal IRC § 41 standards, Nebraska has created a robust and predictable incentive that rewards businesses for solving difficult engineering and scientific problems.

The program’s evolution—from the original Nebraska Advantage Act to its current extension through 2033—demonstrates a consistent legislative commitment to innovation. However, the credit’s value is contingent upon rigorous compliance, not only with the technical “four-part test” but also with administrative mandates like E-Verify and new geopolitical restrictions on foreign ownership. For Nebraska businesses, successfully navigating the Permitted Purpose requirement provides more than just a tax refund; it provides the capital necessary to fuel the next generation of breakthroughs in the fields that define the state’s economy, from precision agriculture to advanced biotechnology. 1

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