This study comprehensively analyzes the federal Research and Development (R&D) tax credit requirements and North Carolina’s state-level tax conformity laws applicable to businesses operating in 2025 and 2026. Through an examination of five distinct industries anchored in Jacksonville, North Carolina, the analysis details how regional enterprises can navigate complex statutory frameworks, leverage alternative economic grants, and optimize innovation capital.

The Macroeconomic and Legislative Landscape of Innovation Capital

The legislative architecture governing research and experimentation expenditures in the United States has undergone significant volatility and restructuring in recent years. For defense contractors, biotechnology firms, aerospace developers, and advanced manufacturers operating in military-adjacent municipalities like Jacksonville, North Carolina, optimizing these tax provisions is paramount for capital retention and competitive viability. At the federal level, the Internal Revenue Code (IRC) governs these incentives primarily through Section 41, which establishes the Credit for Increasing Research Activities, and Section 174, which dictates the amortization and expensing of Research and Experimental (R&E) expenditures. These federal statutes are designed to stimulate domestic technological innovation by providing a dollar-for-dollar reduction in a taxpayer’s federal income tax liability.

Conversely, the state of North Carolina presents a complex, divergent environment characterized by the expiration of its localized R&D credit, significant statutory disconnects from recent federal tax law enactments, and a heavy reliance on alternative discretionary grant programs to incentivize corporate development. The interplay between a highly favorable federal tax regime and a restrictive, decoupled state tax regime requires meticulous strategic planning by corporate financial officers and tax counsel.

This comprehensive study evaluates the specific federal and state R&D tax frameworks applicable in the 2025 and 2026 taxable years. It contextualizes these legal requirements through an exhaustive economic and historical analysis of Jacksonville, North Carolina—a city fundamentally shaped and sustained by the presence of Marine Corps Base Camp Lejeune and Marine Corps Air Station (MCAS) New River. By analyzing the historical, geographic, and infrastructural development of Jacksonville’s key industry sectors, this study provides detailed case studies demonstrating how local enterprises navigate the rigorous eligibility requirements of federal tax law, manage the complexities of state non-conformity, and leverage regional economic development incentives.

The Federal Research and Development Tax Credit Framework

The federal R&D tax credit represents one of the most lucrative, yet heavily scrutinized, mechanisms for corporate tax mitigation. To capture this benefit, taxpayers must navigate a strict set of statutory requirements enforced by the Internal Revenue Service (IRS).

IRC Section 41 and the Four-Part Eligibility Test

Eligibility for the federal R&D tax credit is strictly dictated by IRC Section 41(d), which mandates that every research activity must satisfy a rigorous four-part test to be classified as “qualified research”. These tests must be applied separately to each individual business component—defined as any product, process, computer software, technique, formula, or invention—developed or improved by the taxpayer. Failure to satisfy even one of these criteria renders the associated expenditures ineligible for the credit.

When a project satisfies this four-part test, the associated financial outlays generate Qualified Research Expenses (QREs). Under IRC Section 41(b), QREs utilized to calculate the base amount and the final credit typically include wages paid to employees directly conducting, supervising, or directly supporting the qualified research; the cost of supplies and materials tangibly used or consumed during the research process; and specific percentages of contract research expenses paid to third parties. Notably, under IRC Section 41(b)(3)(C), while standard third-party contractor expenses are eligible at a 65% rate, amounts paid or incurred by the taxpayer to a “qualified research consortium” on behalf of the taxpayer and one or more unrelated taxpayers are eligible to be captured at an elevated 75% rate. A qualified research consortium is strictly defined as a tax-exempt organization organized and operated primarily to conduct scientific research.

IRC Section 174 and the Impact of the One Big Beautiful Bill Act (OBBBA)

The tax treatment of research and experimental expenditures under IRC Section 174 has been a subject of intense legislative turbulence, creating significant cash-flow implications for innovative enterprises. Under the Tax Cuts and Jobs Act (TCJA) of 2017, taxpayers were required, beginning in the 2022 tax year, to abandon the historical practice of immediate expensing and instead capitalize and amortize domestic R&E costs over a mandatory five-year period. This amortization requirement artificially inflated corporate taxable income, severely impacting the liquidity of businesses heavily invested in research and development.

However, the federal legislative landscape shifted dramatically with the passage of the One Big Beautiful Bill Act (OBBBA) (P.L. 119-21) on July 4, 2025. The OBBBA enacted IRC Section 174A, which restored the ability for businesses to fully deduct domestic R&E expenditures in the year they are incurred, effective for tax years beginning after December 31, 2024. Furthermore, the legislation made the R&D tax credit permanent, ending decades of temporary extensions, and provided crucial retroactive relief.

Under the OBBBA provisions, smaller companies—statutorily defined as those with average gross receipts of $31 million or less over the preceding three years—are granted retroactive opportunities to amend tax returns for the 2022, 2023, and 2024 periods to recapture previously capitalized and amortized expenses, generating immediate tax refunds. Alternatively, for the 2025 tax year, taxpayers may elect to deduct their remaining unamortized domestic research expenses previously capitalized under the TCJA rules either fully in the 2025 tax year or spread evenly over a two-year transition period encompassing 2025 and 2026. It is critical to note that the OBBBA’s relief applies exclusively to domestic research; foreign research expenses remain subject to a stringent 15-year capitalization and amortization schedule.

Enhanced IRS Documentation and Compliance Requirements (Form 6765)

Coinciding with the expansion of the credit’s financial benefits, the Internal Revenue Service has significantly increased its administrative substantiation and documentation requirements. Form 6765, the official instrument for claiming the Credit for Increasing Research Activities, has been radically revised for the 2025 and 2026 tax years to mandate the inclusion of extensive qualitative data directly with the originally filed tax return. Historically, Form 6765 was utilized primarily for reporting quantitative financial data, with qualitative technical documentation retained internally by the taxpayer for presentation only in the event of an IRS audit.

Under the updated regulatory guidelines released via IR 2024-313, Section G of Form 6765 will become mandatory for all corporate and individual filers beginning in tax year 2026. This exhaustive new section requires taxpayers to explicitly disclose the total number of business components generating QREs, provide detailed qualitative narratives justifying the four-part test for each individual business component, and report specific quantitative breakdowns of officers’ wages included in the wage QRE calculations. Furthermore, the IRS has implemented heightened reporting standards for controlled groups, requiring precise coordination of credit calculations and Section G reporting across all affiliated entities to ensure proper allocation and prevent double-dipping.

A transition period is available for tax year 2025, allowing optional Section G reporting for specific taxpayer classifications. This safe harbor applies to Qualified Small Businesses (QSBs), as defined under IRC Section 41(h)(3), who elect to utilize the R&D credit to offset the employer portion of their payroll taxes, as well as taxpayers with total QREs of less than $1.5 million and gross receipts of less than $50 million. For all other taxpayers, the failure to provide this qualitative data at the time of filing will result in the immediate rejection of the claim during the perfection period.

Case Law Jurisprudence: The “Funded Research” Exclusion

For defense contractors, aerospace engineers, and military simulation developers operating in regions dominated by federal procurement like Jacksonville, the “funded research” exclusion under IRC Section 41(d)(4)(H) represents the most significant legal hurdle to claiming the credit. The statute dictates that research is entirely disqualified from the credit if it is funded by any grant, contract, or otherwise by another person or governmental entity. To legally prove that research is not funded, and therefore eligible for the credit, the taxpayer bears the burden of demonstrating two critical elements: payment must be contingent on the success of the research (establishing financial risk), and the taxpayer must retain substantial rights to the results of the research.

• Meyer, Borgman & Johnson, Inc. (MBJ) v. CIR: In this pivotal case, the Tax Court emphasized the strict interpretation of financial risk. The taxpayer claimed its contracts tied payment to the success of the research, thereby qualifying its expenses. However, the court concluded that the contractual language did not expressly make payment contingent on achieving specific, uncertain technical research success. Instead, the contracts merely required the delivery of services meeting general professional standards of adequacy. The judgment established that actual financial risk must be explicitly documented within the contract’s payment terms, serving as a warning to defense contractors regarding the exact phrasing of government solicitations.
• Lockheed Martin Corporation v. United States (210 F.3d 1366): This appellate court decision established the definitive precedent regarding the “substantial rights” doctrine. The court concluded that a defense contractor retains substantial rights in the research performed under fixed-price government contracts even if the contractor does not possess the right to exclude others (such as the Department of Defense) from using the research. The court ruled that the right to use the research results in the taxpayer’s own business, even if that right is non-exclusive and subject to military security restrictions, constitutes a substantial right under the tax statute.
• Dynetics: The courts further clarified the boundaries of contract interpretation, ruling that non-research tax credit law—such as state warranty statutes or general commercial case law—cannot be used to interpret whether a contract’s payment is contingent on success. The analysis must remain strictly confined to the “four corners” of the contractual agreement between the taxpayer and the government agency. If the contract does not explicitly state that payment is withheld upon technical failure, the research is deemed funded.
• U.S. v. Davenport (897 F. Supp. 2d 496): Specifically addressing the software exclusion, this case clarified that uncertainty regarding the capability or method of achieving a specific computational result, or the appropriate design of the desired result, must exist at the very beginning of the project. The court ruled that routine quality control testing, debugging, or post-development modifications do not constitute a process of experimentation, setting a high bar for military software developers seeking the credit.

The North Carolina State Tax Landscape and Conformity Dynamics

While the federal government has expanded innovation incentives through the OBBBA, the state-level tax framework in North Carolina presents a divergent, restrictive reality characterized by expired statutory credits and complex federal decoupling mechanisms.

The Expiration of North Carolina General Statutes Article 3F

Historically, North Carolina offered a robust and highly competitive state-level R&D tax credit, codified under General Statutes Chapter 105, Article 3F. This statute provided a tiered credit structure, allowing businesses to claim up to 13.5% of eligible QREs to offset state corporate or individual income tax liabilities. The program was particularly advantageous for entities collaborating with local academia, offering a specialized credit for “North Carolina university research expenses” defined as amounts paid or incurred to a constituent institution of The University of North Carolina for qualified basic research performed within the state.

However, the Article 3F R&D credit officially sunset and expired on December 31, 2015, and it remains unavailable for the 2025 and 2026 tax years. While persistent legislative attempts, such as Senate Bill 354, have been introduced in the General Assembly to reenact and modify the credit, these bills have consistently stalled in committee and remain unenacted as of early 2026. Consequently, businesses conducting advanced R&D in North Carolina cannot currently claim a state-specific R&D tax credit, though they maintain full eligibility to claim the federal credit for the geographic activities performed within the state’s borders.

Statutory Disconnect: North Carolina Conformity to IRC Section 174

The most pressing tax compliance issue for innovative companies operating in North Carolina during the 2025–2026 period is the state’s explicit lack of conformity to the newly enacted federal OBBBA legislation. The North Carolina Revenue Act dictates that the state’s corporate and individual income tax calculations must begin with the Internal Revenue Code exactly as it was enacted on a specific reference date—currently January 1, 2023.

Because the North Carolina General Assembly has not yet enacted legislation to update this reference date to adopt post-2023 federal tax changes, the state explicitly decouples from the OBBBA provisions, including the restoration of 100% immediate expensing under IRC Section 174 and 174A.

Consequently, for tax year 2025, corporations calculating their Federal Taxable Income (FTI) and individuals calculating Adjusted Gross Income (AGI) for North Carolina state tax purposes must mathematically exclude the new federal 174 expensing rules. Taxpayers are required to continue capitalizing and amortizing their domestic R&E expenditures over a five-year period for state tax purposes, generating a substantial reconciliation difference that artificially inflates state taxable income.

Because the General Assembly is not scheduled to reconvene until mid-April 2026, taxpayers face severe timing issues regarding the April 15 corporate filing deadline. The North Carolina Department of Revenue (NCDOR) has issued guidance advising taxpayers to either file a formal extension—delaying the return while awaiting potential legislative conformity updates—or file on time utilizing a recalculated state taxable income with an attached schedule reconciling the difference between the 2025 Code and the 2023 Code.

Alternative Economic Development Incentives

In the complete absence of a localized, statutory R&D tax credit, North Carolina relies heavily on discretionary economic development programs to attract, retain, and subsidize high-technology enterprises and defense contractors. The state’s flagship program is the Job Development Investment Grant (JDIG). JDIG is a highly competitive, performance-based incentive that provides annual cash grants for a period of up to 12 years to new and expanding businesses. For massive capital investments, companies that create at least 1,750 jobs and invest $500 million are categorized as High-Yield Projects (HYP), allowing a grant period of up to 20 years.

The grant amount is precisely calculated as a percentage of the state personal income tax withholdings from the newly created jobs. The program is geographically tiered based on the economic distress of the county. In Onslow County—the home of Jacksonville, which operates as a designated Tier 2 county—90% of the calculated JDIG annual grant is paid directly to the company, while the remaining 10% is transferred to the state’s Utility Account to fund rural infrastructure projects across the state.

Furthermore, the state utilizes the One North Carolina Fund (One NC), which allocates awards to local units of government as part of a negotiated challenge grant. Local governments are required to match the One NC award with cash, fee waivers, in-kind services, or the donation of land and infrastructure to assist the expanding corporation. For R&D facilities establishing operations in Jacksonville, these discretionary grants function as the primary state-level financial mechanism to offset development costs and labor overhead.

The Economic and Geographic Catalyst of Jacksonville, North Carolina

To accurately understand the nature of the R&D activities conducted in Jacksonville, it is necessary to examine the region’s historical and geographic foundations, which have created a highly specialized, monopsonistic economic environment.

Situated along the banks of the New River in Onslow County, the area that would eventually become Jacksonville originally centered around Wantland’s Ferry in the mid-18th century, established shortly after the conclusion of the Tuscarora wars in 1713. The region initially operated as an agrarian hub, primarily serving as a center of production for naval stores, turpentine, and timber. The local economy remained largely stagnant and lumber-dependent until the arrival of the Atlantic Coast Line (ACL) railroad in 1893, which provided freight access to distant commercial markets.

However, the definitive, monumental turning point in Jacksonville’s economic history occurred in 1941 with the establishment of Marine Corps Base Camp Lejeune by the United States Department of War. The federal government selected the area specifically for its unique coastal geography; the base encompasses 246 square miles of land, including 14 miles of pristine Atlantic beach frontage and deep-water access strategically situated between the major ports of Wilmington and Morehead City. This specific topography provided an unparalleled, highly realistic operational zone for developing, sustaining, and rehearsing amphibious assault training.

Today, Camp Lejeune and the adjacent Marine Corps Air Station (MCAS) New River thoroughly dominate the regional economy. The installations generate nearly $3 billion in annual commerce, directly supporting a base population of over 120,000 active duty service members, dependents, retirees, and civilian employees. Demographically, Jacksonville holds the unique distinction of being the youngest city in the United States, with an average age of 22.8 years, a statistic driven entirely by the massive influx of young military recruits and their families.

This massive military footprint has forced a localized industrial clustering, drawing defense contractors, aerospace engineers, and federal construction firms into the immediate geographic orbit of the bases. The concentration of 43,000 military jobs and the continual rotation of 6,000 Marines ending their enlistments annually provides a highly trained, specialized workforce for local technology firms. In recent years, the City of Jacksonville has deliberately pivoted through organizations like the Jacksonville Onslow Economic Development (JOED) to incubate this clustering, establishing dedicated business parks to attract advanced manufacturing, simulation technology, and defense services. Furthermore, a $3.6 billion military construction (MILCON) recovery program initiated after the devastation of Hurricane Florence in 2018 has poured unprecedented federal capital into the local construction and engineering sectors. Consequently, the private-sector R&D conducted in this region is inextricably linked to defense requirements, coastal engineering resilience, and military healthcare.

Industry Case Studies: Jacksonville’s R&D Footprint

The following five exhaustive case studies analyze unique, highly specialized industries that have geographically anchored themselves in Jacksonville. Each study examines the historical rationale for the industry’s local development and analyzes how hypothetical, highly representative corporate projects would qualify under the strict criteria of federal IRC Section 41, while simultaneously navigating North Carolina’s complex alternative incentive structures and conformity laws.

Strategic Compliance and Contract Optimization for Jacksonville Enterprises

The complex intersection of federal and state tax law in the 2025 and 2026 taxable years requires meticulous, proactive strategic planning by corporate financial officers, tax counsel, and engineering directors operating in Jacksonville.

Because North Carolina has affirmatively chosen not to conform to the federal OBBBA, the immediate expensing of Section 174 costs for federal returns will cause a severe, inescapable mismatch with the state return. Jacksonville businesses must implement and maintain sophisticated dual-track accounting systems: one ledger tracking the 100% immediate deduction to satisfy the IRS, and a secondary ledger tracking the 5-year amortization schedule required by the North Carolina Department of Revenue. This statutory disconnect creates a deferred tax liability on corporate balance sheets that must be carefully managed. For businesses generating substantial QREs—such as the simulation software developers or the advanced materials engineers outlined in the preceding case studies—the failure to properly calculate and add back the amortized difference on the North Carolina state return will inevitably trigger NCDOR audits, leading to substantial underpayment penalties and compounding interest.

Furthermore, Jacksonville’s private sector is intrinsically tethered to federal procurement. As definitively established in Meyer, Borgman & Johnson and Lockheed Martin, a company cannot claim the R&D credit if the government bears the financial risk or holds exclusive rights to the developed technology. To preserve their innovation capital, Jacksonville firms must aggressively negotiate for firm-fixed-price contracts over cost-plus-reimbursement contracts. In a cost-plus contract, the government reimburses the contractor for research expenses regardless of the technical outcome, meaning the government bears the financial risk (resulting in disqualified funded research). In a firm-fixed-price contract, the contractor receives a set amount only if the prototype meets the rigorous specifications; if the R&D fails and costs overrun, the contractor absorbs the financial loss, thus establishing the requisite financial risk for IRC Section 41 eligibility. Additionally, intellectual property clauses within Department of Defense solicitations must explicitly reserve the contractor’s right to exploit the developed technologies in civilian or commercial markets to legally satisfy the “substantial rights” requirement.

Ultimately, the unique economic geography of Jacksonville—anchored by the monumental presence of Camp Lejeune and MCAS New River—will continue to serve as a highly specialized, fertile incubator for advanced defense textiles, military simulation software, coastal engineering materials, marine biotechnology, and clinical trauma research. By carefully structuring defense contracts to preserve substantial rights and financial risk, meticulously complying with the IRS Form 6765 Section G documentation mandates, and strategically leveraging targeted local economic grants like JDIG and One NC in lieu of expired state tax credits, these localized industries can maximize their capital efficiency and sustain the technological superiority required by their primary military consumers.