Industry Case Studies: R&D Eligibility and Regional Development in Raleigh, NC

The Raleigh, North Carolina metropolitan area, anchored by the Research Triangle Park (RTP), represents one of the most concentrated innovation ecosystems in the United States. Transforming from a mid-20th-century economy dependent on legacy agriculture and traditional manufacturing, the region systematically engineered a knowledge-based economy. This transformation was driven by strategic state investments, the proximity of three Tier-1 research universities (North Carolina State University, Duke University, and the University of North Carolina at Chapel Hill), and targeted tax incentives. The following case studies explore the historical development of five prominent industries in Raleigh and demonstrate how specific activities within these sectors satisfy the rigorous requirements of United States federal and North Carolina state R&D tax laws.

Biotechnology and Biopharmaceutical Manufacturing

Historical Development in Raleigh: Raleigh’s emergence as a premier biotechnology hub was not an organic phenomenon but the result of deliberate, decades-long economic planning. In the 1950s, North Carolina suffered from a severe “brain drain” and one of the lowest per capita incomes in the nation due to its reliance on tobacco, textiles, and furniture. Governor Luther Hodges, alongside corporate and academic leaders, established the Research Triangle Park in 1959 to pivot the state toward high-technology research. The critical inflection point for biotechnology occurred in 1984 when the North Carolina General Assembly created the North Carolina Biotechnology Center (NCBiotech), the nation’s first state-funded non-profit dedicated entirely to life sciences economic development.

Simultaneously, the federal Bayh-Dole Act of 1980 allowed the Triangle’s research universities to commercialize and license their intellectual property, sparking a massive influx of pharmaceutical investment. Decades of sustained investment transformed the region into the third-largest biotechnology cluster in the United States, hosting over 600 life science companies. Today, the region supports a massive biomanufacturing workforce exceeding 75,000 individuals, anchored by multinational corporations such as Biogen, Novo Nordisk, and Pfizer, and supported by specialized training facilities like NC State’s Biomanufacturing Training and Education Center (BTEC).

R&D Tax Credit Eligibility Case Study:

Scenario: A Raleigh-based Contract Development and Manufacturing Organization (CDMO) initiates a project to scale up the bioprocessing of a highly complex, mammalian-cell-derived monoclonal antibody from a 50-liter laboratory scale to a 5,000-liter commercial bioreactor.

• Permitted Purpose: The company is developing a new, scalable biomanufacturing process to improve the yield, purity, and functional reliability of the active pharmaceutical ingredient (API).
• Elimination of Uncertainty: At the onset of the scale-up, there is profound technological uncertainty regarding whether the host cell lines will maintain viability, stability, and expression rates under the vastly different fluid dynamics, oxygen transfer rates, and shear stress present in the 5,000-liter environment.
• Process of Experimentation: The CDMO’s biochemical engineers systematically test multiple variables. They design experimental matrices altering sparge rates, impeller agitation speeds, pH levels, and nutrient feed strategies. They run pilot batches, analyzing the outputs via mass spectrometry to evaluate protein aggregation and titer yield, iteratively refining the parameters until the optimal commercial process is established.
• Technological in Nature: The research fundamentally relies on principles of cellular biology, organic chemistry, and fluid engineering.

Federal and State Law Application: Under United States federal law (IRC Section 41), the wages paid to the biochemical engineers directly conducting the scale-up, the laboratory technicians directly supporting the assays, and the management directly supervising the trials qualify as in-house research expenses. Furthermore, the biological reagents, nutrient media, and host cells consumed during the failed iterative testing batches qualify as supply QREs. Crucially, the CDMO must ensure their contracts with the pharmaceutical sponsor are structured as fixed-price agreements where the CDMO bears the economic risk of failure, thereby avoiding the Section 41 “funded research” exclusion highlighted in the Smith v. Commissioner case.

Under North Carolina state law, while the primary Article 3F income tax credit expired in 2015, the CDMO would benefit immensely from the state’s Sales and Use Tax exemption. Pursuant to N.C. Gen. Stat. § 105-164.13(5g), because the CDMO is primarily engaged in physical, engineering, and life sciences research (NAICS 54171), the purchase of the $2 million pilot bioreactor and associated analytical equipment is entirely exempt from state sales tax, provided it is capitalized under the IRC and used for R&D. Should Senate Bill 354 (NC Breakthrough Act) be enacted, the company could additionally claim a tiered income tax credit of 1.25% to 3.25% on these QREs to offset North Carolina corporate franchise taxes.

Information Technology and Software Development

Historical Development in Raleigh: The software and information technology (IT) sector in Raleigh possesses a rich history that parallels the growth of RTP. A foundational moment occurred in 1965 when IBM established a massive complex in RTP, creating an anchor for technological talent. This talent base allowed for homegrown successes, most notably the SAS Institute. Founded in 1976 by James Goodnight and Anthony Barr as a spin-out from an agricultural data project at NC State University, SAS grew into the world’s largest privately held software company, turning the Raleigh suburb of Cary into a global epicenter for analytics and business intelligence.

The region’s IT identity was further solidified in the 1990s with the founding of Red Hat by Bob Young and Marc Ewing. By establishing its global headquarters in downtown Raleigh, Red Hat championed the open-source software model, specifically enterprise Linux distributions, challenging proprietary tech giants. Red Hat’s philosophy fostered a highly collaborative tech culture in Raleigh, leading to its acquisition by IBM for $34 billion in 2019. Today, the region employs over 60,000 tech professionals across thousands of software, cybersecurity, and data architecture firms.

R&D Tax Credit Eligibility Case Study:

Scenario: An enterprise software publisher headquartered in downtown Raleigh is developing a novel, predictive Artificial Intelligence (AI) framework. The software aims to ingest unstructured global supply chain data (e.g., weather patterns, geopolitical risk feeds, port congestion metrics) to autonomously reroute international shipping logistics in real-time.

• Permitted Purpose: The company is developing new computer software to create advanced functionality and significantly improve the performance and predictive reliability of logistics routing.
• Elimination of Uncertainty: At the beginning of the project, it is fundamentally uncertain whether the proposed neural network architecture can ingest and normalize petabytes of unstructured data with low enough latency to execute sub-second routing updates without system failure.
• Process of Experimentation: Software engineers engage in an iterative process. They code multiple algorithmic models (e.g., evaluating Recurrent Neural Networks against Transformer models), subject them to high-volume stress tests, measure the predictive accuracy and latency, identify architectural bottlenecks, and systematically rewrite the codebase to eliminate the identified latency issues.
• Technological in Nature: The development fundamentally relies on the principles of computer science and complex data architecture.

Federal and State Law Application: For federal purposes under IRC Section 41, the wages paid to the software architects, data scientists, and DevOps engineers actively coding and testing the AI framework qualify as QREs. Because the software is being developed for commercial licensing to third-party logistics firms, it successfully avoids the highly restrictive “Internal Use Software” (IUS) exclusion that requires an elevated threshold of innovation. Furthermore, cloud-hosting fees paid to third parties (e.g., AWS or Azure) specifically for the right to use computers to host the isolated R&D testing and staging environments qualify as computer rental QREs.

From a North Carolina perspective, the software publisher can utilize N.C. Gen. Stat. § 105-164.13(5h). This statute explicitly exempts companies engaged in software publishing (NAICS 5112) from paying sales and use tax on capitalized equipment used in the research and development of tangible personal property. If the company purchases on-premise high-performance computing (HPC) servers for model training, these capital expenditures are tax-exempt. Should the NC Breakthrough Act (SB 354) pass, the software publisher’s QREs would become eligible for the state R&D credit, which could offset their corporate income tax liability.

Clean Technology (Cleantech) and Smart Grids

Historical Development in Raleigh: Raleigh and the broader Triangle region contain one of the world’s highest concentrations of Clean Technology (Cleantech) enterprises, with over 1,900 companies operating in the sector. The origins of this cluster trace back to the establishment of NC State University’s Centennial Campus in 1984, a massive public-private innovation district built on former state hospital land. Centennial Campus was designed to blur the lines between academia and industry. In 1991, ABB became the first major corporate partner to locate its operations on the campus, eventually establishing its Smart Grid Center of Excellence.

The region’s capabilities were supercharged by the creation of the FREEDM Systems Center at NC State, a National Science Foundation Engineering Research Center dedicated to building the “smart grid of tomorrow” to handle bidirectional power flows from distributed renewable energy sources. Today, Raleigh’s cleantech cluster focuses heavily on energy storage, microgrid controllers, and sustainable energy infrastructure.

R&D Tax Credit Eligibility Case Study:

Scenario: A Raleigh-based cleantech engineering firm is developing a proprietary firmware controller for a commercial-scale Battery Energy Storage System (BESS). The controller must predictively discharge power to the municipal grid during peak demand while simultaneously managing thermal loads to prevent runaway overheating in the lithium-ion cells.

• Permitted Purpose: The development of an improved business component (firmware and physical controller) to enhance the reliability and safety performance of grid-scale energy storage.
• Elimination of Uncertainty: There is specific engineering uncertainty regarding whether the proposed thermal management algorithms can accurately predict and mitigate heat spikes across thousands of linked battery cells under variable discharge loads.
• Process of Experimentation: The firm’s electrical engineers and software developers build sub-scale physical pilot models. They run continuous charge and discharge simulations, systematically adjusting the firmware’s cooling activation thresholds. They evaluate the alternatives by monitoring real-time thermal output and latency of the cooling response, reiterating the code until the thermal parameters remain stable under peak load.
• Technological in Nature: The project is rooted in electrical engineering, thermodynamics, and computer science.

Federal and State Law Application: Federally, the wages of the engineers and the cost of the raw materials (e.g., prototype circuit boards, test lithium-ion cells) consumed and destroyed during the thermal stress testing qualify as QREs. To survive IRS scrutiny, particularly following the Little Sandy Coal decision, the firm must maintain contemporaneous, time-tracked documentation proving that over 80% of the employees’ activities involved this systematic evaluation of alternatives, rather than routine assembly or quality control.

Under North Carolina law, if the cleantech firm outsources a portion of the advanced thermal modeling to researchers at the FREEDM Systems Center at NC State University, these costs would hold special status. While the federal credit captures 65% of contract research expenses (or 75% for qualified research consortiums), the proposed North Carolina SB 354 legislation specifically carves out “North Carolina university research expenses.” Under the pending law, payments made to a constituent institution of the UNC system (like NC State) for qualified research performed in the state yield a dramatically higher 20% tax credit rate, incentivizing direct corporate-academic collaboration.

Agricultural Technology (AgTech) and Plant Genetics

Historical Development in Raleigh: Agriculture is the economic bedrock of North Carolina, contributing over $111 billion annually to the state’s economy. Recognizing that traditional farming faced existential threats from climate change, supply chain volatility, and population growth, state leaders sought to merge North Carolina’s massive agricultural footprint with RTP’s deep biotechnology expertise.

This strategic alignment culminated in the creation of the North Carolina Plant Sciences Initiative (N.C. PSI), housed in a state-of-the-art facility on NC State’s Centennial Campus. The initiative serves as a collaborative hub for farmers, academic geneticists, and corporate agribusinesses. The region has subsequently attracted over 100 AgTech companies, including global giants like BASF Agricultural Solutions and Bayer, as well as highly innovative startups like Pairwise, which utilizes genome editing to create novel crop varieties.

R&D Tax Credit Eligibility Case Study:

Scenario: An AgTech startup located in the Research Triangle Park is utilizing CRISPR/Cas9 genome editing technology to develop a new varietal of row crop designed specifically to exhibit extreme drought resistance for deployment in eastern North Carolina’s sandy soils.

• Permitted Purpose: The development of a new, genetically improved plant varietal intended to increase performance (crop yield) and reliability (drought survival).
• Elimination of Uncertainty: The startup faces scientific uncertainty regarding the exact sequence of guide RNA (gRNA) necessary to target the specific allele responsible for the plant’s water retention mechanisms without inducing off-target, deleterious phenotypic mutations.
• Process of Experimentation: Geneticists utilize directed mutagenesis. They synthesize multiple variations of the gRNA, deliver them to host cells using viral vectors, and cultivate the resulting plant lines in controlled rooftop greenhouse environments (such as those at N.C. PSI). The plants are subjected to systematic drought stress evaluations. Researchers analyze survival rates and utilize genomic sequencing to evaluate the efficacy of each edit, discarding failed lines until the optimal genetic modification is confirmed.
• Technological in Nature: The research is entirely reliant on the biological sciences, molecular genetics, and bioinformatics.

Federal and State Law Application: For the federal R&D credit, the wages of the geneticists, agronomists, and laboratory technicians constitute qualifying in-house labor. Furthermore, the costs of highly specialized laboratory supplies—including CRISPR enzymes, sequencing reagents, growth media, and the seeds consumed during the stress testing—are fully includable as supply QREs.

In North Carolina, the company’s status as a research facility rather than a traditional farm is crucial for indirect tax planning. While standard commercial farms utilize N.C. Gen. Stat. § 105-164.13E to exempt agricultural inputs (fertilizer, tractor fuel), the AgTech startup operates as an R&D entity. Therefore, its purchase of capital equipment, such as million-dollar next-generation sequencing machines or controlled environmental chambers, is exempt from North Carolina Sales and Use Tax under the physical and life sciences exemption in G.S. 105-164.13(5g). If the startup generates less than $1 million in annual receipts, the prospective SB 354 legislation classifies them as a “Small Business,” entitling them to a flat 3.25% income tax credit on all qualified North Carolina research expenses, which is highly beneficial for pre-revenue biotechnology firms scaling their operations.

Advanced Manufacturing and Materials Science

Historical Development in Raleigh: In the late 20th century, globalization and international trade agreements severely impacted North Carolina’s traditional manufacturing base in textiles and furniture. In response, the state leveraged its expansive community college system and university engineering programs to transition its workforce into advanced, knowledge-based manufacturing. The Research Triangle region became a focal point for this shift, drawing heavily on chemical engineering, materials science, and power electronics.

Today, the region is experiencing a massive industrial renaissance fueled by federal incentives like the CHIPS Act and the Inflation Reduction Act. The Raleigh area has become a destination for cutting-edge semiconductor manufacturing (e.g., Wolfspeed’s silicon carbide facilities) and advanced battery material production (e.g., Forge Nano’s ALD gigafactory), capitalizing on a regional workforce where over 30,000 STEM degrees are awarded annually.

R&D Tax Credit Eligibility Case Study:

Scenario: An advanced materials manufacturer operating a facility near Raleigh is developing a proprietary Atomic Layer Deposition (ALD) nanocoating process. The objective is to apply a microscopic, defect-free protective layer to silicon anodes, thereby increasing the energy density and cycle lifespan of electric vehicle (EV) batteries.

• Permitted Purpose: The manufacturer is attempting to improve the performance and quality of both a manufacturing process (the ALD coating method) and a product (the resulting silicon anode).
• Elimination of Uncertainty: There is profound capability and method uncertainty regarding the exact thermodynamic parameters required. The engineers do not know the precise combination of precursor gas flow rates, vacuum chamber pressure, and sustained temperature necessary to achieve a uniform nanocoating at speeds viable for commercial scale.
• Process of Experimentation: Utilizing a dedicated pilot testbed facility, the engineering team establishes a systematic matrix of variables. They iterate through different vacuum pressures and precursor gas exposure times. Following each cycle, they analyze the coated anodes using electron microscopy to evaluate coating thickness, uniformity, and defect rates. They refine the atmospheric variables until the optimal deposition parameters are achieved.
• Technological in Nature: The activities rely strictly on physical chemistry, thermodynamics, materials science, and mechanical engineering.

Federal and State Law Application: To claim the federal IRC Section 41 credit, the manufacturer must strictly adhere to the exclusion for “research after commercial production” defined in Section 41(d)(4). QREs—including the wages of the materials scientists and the cost of the raw silicon and precursor gases consumed—are only eligible before the ALD process is validated and locked for commercial manufacturing. Subsequent quality control (QA/QC) testing of the anodes during standard production is statutorily excluded.

Under North Carolina law, the manufacturer benefits heavily from the Mill Machinery Exemption. The massive capital investment required to purchase the ALD machinery and vacuum chambers is exempt from standard state sales and use tax. Notably, the NCDOR’s administrative authority to deny such exemptions was recently curtailed by the North Carolina Supreme Court in N.C. Dep’t of Revenue v. FSC II LLC (2024). The court ruled that a company qualifies as a “manufacturing industry” entitled to the exemption even if it uses the manufactured components internally (e.g., integrating the anodes into proprietary battery packs) rather than selling the raw materials directly to third parties, rejecting the NCDOR’s arbitrary “primary purpose” sales threshold. Under the prospective SB 354, a large manufacturer of this scale would fall into the tiered expense structure, claiming a state tax credit ranging from 1.25% to 3.25% on their multi-million dollar QRE base.

Detailed Analysis of United States Federal R&D Tax Credit Laws and Guidance

The United States federal government leverages the Internal Revenue Code (IRC) to incentivize domestic innovation. The primary mechanisms are the immediate deduction of research costs under IRC Section 174 and the Credit for Increasing Research Activities under IRC Section 41. Together, these statutes present a highly complex, heavily litigated framework requiring strict administrative compliance.

The Intersection of Section 174 and Section 41

To be eligible for the Section 41 R&D tax credit, an expenditure must first qualify as a research and experimental (R&E) expenditure under IRC Section 174. Historically, taxpayers had the option to immediately expense Section 174 costs in the year incurred. However, the Tax Cuts and Jobs Act (TCJA) of 2017 mandated that, beginning in tax year 2022, all domestic R&E expenditures had to be capitalized and amortized over five years (15 years for foreign research), creating significant cash-flow burdens for innovative companies.

This landscape was drastically altered by the passage of the One Big Beautiful Bill Act (OBBBA) in July 2025. The OBBBA reinstated and made permanent the immediate expensing of domestic R&E expenditures under Section 174A, restoring a critical financial incentive for US-based manufacturing and software development. Despite this relief, the IRS continues to rigorously enforce the boundaries of what constitutes “qualified research” under Section 41.

Statutory Requirements: The Four-Part Test

As outlined in the case studies, IRC Section 41(d) demands that every business component pass a four-part test. Failure to satisfy any single prong disqualifies the entire component.

Qualified Research Expenses (QREs)

The financial benefit of the credit is dictated by the volume of Qualified Research Expenses (QREs) captured under IRC Section 41(b). The statute restricts QREs to three distinct categories, disallowing overhead, general administrative costs, and depreciation.

• Wages: The cost of taxable labor (subject to withholding under Section 3401(a)) for employees performing “qualified services”. This includes not only the engineer directly performing the laboratory test but also the direct supervisor reviewing the data, and the support staff directly assisting the test.
• Supplies: Any tangible property consumed or destroyed in the conduct of qualified research. This explicitly excludes land, improvements to land, and depreciable property (capital equipment). The IRS strictly enforces this; general production supplies do not qualify.
• Contract Research Expenses: When a taxpayer outsources R&D, 65% of the amount paid to the third party qualifies as a QRE, provided the taxpayer retains substantial rights to the research results and bears the economic risk of failure (i.e., must pay the contractor even if the research fails). If the research is performed by a qualified research consortium (e.g., a 501(c)(3) university), the allowable percentage increases to 75%.

Statutory Exclusions and the “Funded Research” Doctrine

Even if activities pass the four-part test, IRC Section 41(d)(4) strictly excludes certain research. Notable exclusions include research in the social sciences, research conducted after commercial production begins, adaptation of existing products, and foreign research.

The most heavily litigated exclusion is Funded Research. Research is considered funded—and thus ineligible for the credit—if the taxpayer does not bear the financial risk of failure or does not retain substantial rights to the intellectual property.

Federal Case Law Developments (2020-2025)

Recent judicial decisions have heavily favored the IRS, placing a profound burden of proof on taxpayers regarding documentation and the process of experimentation.

• Little Sandy Coal Co., Inc. v. Commissioner (7th Cir. 2023): This ruling redefined the evidentiary standard for the “Process of Experimentation” test. A shipbuilding company attempted to claim QREs for the design of a novel vessel, using high-level estimates to claim that their engineers were engaged in research. The Tax Court, affirmed by the 7th Circuit, denied the credit entirely, stating that the taxpayer failed to prove that at least 80% of the activities constituted a true process of experimentation. The court ruled that merely building a first-in-class product does not automatically equate to experimentation. Taxpayers must provide a “principled way”—such as real-time project time-tracking tied to specific hypothesis testing—to prove the 80% threshold.
• Phoenix Design Group, Inc. v. Commissioner (Tax Court 2024): This case reinforced the strictness of the “Elimination of Uncertainty” prong. An engineering firm claimed credits for designing complex HVAC and plumbing systems for hospitals. The court denied the claims, ruling that the firm failed to identify specific technological uncertainties at the outset. Iterative design work performed merely to comply with standard building codes or client specifications constitutes routine engineering, not qualified research.
• Smith v. Commissioner and System Technologies, Inc. v. Commissioner (Tax Court 2024/2025): These cases centered on the “Funded Research” exclusion. The IRS aggressively utilized summary judgment motions to deny credits, arguing that contracts shielding taxpayers from risk meant the research was funded by the client. In Smith, an architecture firm successfully defeated the IRS’s motion by demonstrating that their fixed-price contracts inherently forced the firm to absorb the financial risk of necessary redesigns, and that state/local law vested copyright of the designs with the firm, satisfying the “substantial rights” requirement. These cases illustrate that the IRS will forensically examine customer contracts to deny QREs.

IRS Administrative Guidance and Form 6765 Revisions

In response to widespread documentation failures, the IRS has fundamentally restructured how taxpayers claim the R&D credit. Following Chief Counsel Memorandum 20214101F, which mandated exhaustive documentation for refund claims, the IRS overhauled Form 6765 (Credit for Increasing Research Activities) for the 2024/2025 tax years.

The new form introduces “Section G,” which abandons the historical practice of reporting aggregate QREs. Taxpayers must now provide a qualitative breakdown identifying every individual business component, the specific scientific uncertainty faced, the alternatives evaluated, and the exact QREs (wages, supplies, contract costs) allocated to that single component. This administrative change forces companies to adopt granular, real-time R&D project tracking systems to survive the IRS’s automated “Classifier” gating system, which automatically denies claims lacking component-level detail.

Detailed Analysis of North Carolina State R&D Tax Credit Laws and Guidance

North Carolina has utilized tax policy as a primary lever to support the transition of regions like Raleigh into advanced technology hubs. The state’s framework historically relied on the Article 3F income tax credit, and currently relies on broad sales and use tax exemptions administered by the North Carolina Department of Revenue (NCDOR).

The Expiration of Article 3F and the Push for Reenactment

The primary vehicle for state-level R&D incentives was Article 3F of Chapter 105 of the General Statutes. Enacted to parallel the federal IRC Section 41 credit, Article 3F allowed taxpayers to claim a percentage of their qualified North Carolina research expenses against their state corporate franchise or income taxes. However, the statute contained a built-in sunset provision and officially expired for taxable years beginning on or after January 1, 2016. Consequently, no standard state R&D income tax credit is available for the 2024 tax year.

Senate Bill 354: The NC Breakthrough Act (2025-2026 Session) To restore the state’s competitive advantage in attracting innovation clusters, the North Carolina General Assembly introduced Senate Bill 354 (the “NC Breakthrough Act”) in March 2025. The bill, heavily backed by bipartisan sponsors, seeks to retroactively reenact and modify Article 3F for taxable years beginning January 1, 2025, extending the sunset date to 2040.

If enacted, SB 354 will drastically alter the compliance landscape for North Carolina taxpayers. While it adopts the federal IRC Section 41 definition of QREs, it imposes strict socioeconomic taxpayer standards to qualify for the credit:

• Wage Standard: Taxpayers operating in Tier 2 or Tier 3 development areas must meet stringent wage standards, ensuring their average weekly wage exceeds local or state averages (e.g., 110% of the state average).
• Health Insurance: The taxpayer must pay at least 50% of healthcare premiums for all full-time employees at the facility claiming the credit.
• Environmental and Safety Compliance: The taxpayer must certify a lack of serious environmental disqualifying events and no willful serious OSHA violations resulting in final orders within the preceding three years.

The proposed credit structure is tiered to incentivize specific behaviors, offering 3.25% for Small Businesses (receipts under $1M) and low-tier research, a massive 20% credit for research expenses paid to North Carolina universities (directly supporting institutions like NC State and Duke), and 35% for research conducted in Eco-Industrial Parks. The credit is capped at 15% of the taxpayer’s franchise or income tax liability, down from the historical 50% cap. As of mid-2026, the bill remains under review in the Senate Rules and Operations Committee.

Administrative Note: The NCDOR issued an Important Notice in January 2026 clarifying that North Carolina has not yet updated its state code to conform to federal tax legislation (such as the OBBBA) enacted after January 1, 2023. Taxpayers calculating their North Carolina taxable income for 2025 must actively decouple from federal R&E immediate expensing provisions, requiring complex recalculations and reconciliation statements until conformity legislation is passed by the General Assembly.

North Carolina Sales and Use Tax Exemptions for R&D Equipment

While the income tax credit awaits legislative action, the NCDOR actively administers aggressive Sales and Use Tax exemptions that provide immediate, massive capital relief to R&D entities in Raleigh.

Under N.C. Gen. Stat. § 105-164.13, specific industries are statutorily exempt from paying sales tax on the purchase of equipment, attachments, and repair parts. Unlike the federal credit, which excludes depreciable property, this state exemption explicitly targets capital expenditures.

These exemptions are critical for the capital-intensive scale-up of biotechnology firms purchasing bioreactors, or software firms purchasing high-performance computing clusters in the RTP area.

North Carolina State Case Law and Administrative Overreach

The interpretation and enforcement of North Carolina’s tax incentives are governed by state administrative law and judicial review. Recent litigation in the North Carolina Business Court and Supreme Court has severely restricted the NCDOR’s ability to deny statutory tax benefits through administrative fiat or by inappropriately importing federal legal doctrines.

• McCabe v. N.C. Dept. of Revenue and North Carolina Farm Bureau Mutual Insurance Co. (NC Business Court 2023): These cases represent a landmark defeat for the NCDOR regarding state investment tax credits. During a period when North Carolina offered a 35% tax credit for renewable energy property investments, project sponsors utilized syndicators (like Monarch Tax Credits) to pool capital from individual and corporate investors (like the Farm Bureau) via partnerships. The NCDOR audited these investors and disallowed hundreds of millions of dollars in claimed credits. The Department argued that under the federal “economic substance” doctrine, the investors were not “bona fide partners” because their primary motivation was securing the tax credit rather than traditional profit. Judge Adam Conrad of the Business Court ruled decisively in favor of the taxpayers. The court held that the NCDOR cannot apply federal common law doctrines to override explicit North Carolina statutory schemes. The General Assembly specifically designed the tax credit to attract capital that otherwise would not invest; penalizing investors for acting exactly as the legislature intended was unlawful. This ruling protects R&D entities and their investors from NCDOR audits that attempt to use federal anti-abuse doctrines to deny state-sanctioned incentives.
• N.C. Dep’t of Revenue v. FSC II LLC (NC Supreme Court 2024): This case clarified the state’s Mill Machinery Exemption, which shares statutory DNA with the R&D equipment exemptions in G.S. 105-164.13. An asphalt producer claimed a sales tax exemption on its manufacturing equipment. The NCDOR denied the exemption, arguing that because the taxpayer used the majority (79%-85%) of its produced asphalt in its own downstream construction projects rather than selling it to third parties, it was not “primarily engaged” as a manufacturer. The North Carolina Supreme Court affirmed the lower court’s rejection of the NCDOR’s position. The court ruled that the statute simply requires the taxpayer to manufacture a product; it does not contain a “51% rule” demanding commercial sales to third parties. This precedent is vital for advanced manufacturing and R&D firms in Raleigh (such as battery or semiconductor developers) who utilize their manufactured prototypes internally for further R&D rather than immediate commercial sale, ensuring their capital equipment remains tax-exempt.

Final Thoughts

The landscape of Research and Development tax incentives in the United States is characterized by high statutory complexity, profound financial impact, and evolving administrative enforcement. At the federal level, the interaction between IRC Section 174 and Section 41 creates both opportunities and severe compliance burdens. While the recent OBBBA legislation restored the immediate expensing of domestic R&E, the IRS has concurrently tightened its administrative grip. The introduction of granular, component-level reporting in Form 6765, coupled with aggressive judicial precedents like Little Sandy Coal and Phoenix Design Group, demands that taxpayers implement rigorous, real-time documentation of their scientific uncertainties and processes of experimentation to survive audit scrutiny.

For innovative enterprises located in Raleigh, North Carolina, the regional environment remains highly conducive to technical and commercial development. The historical legacy of the Research Triangle Park—driven by strategic government alignment, Tier-1 academic institutions, and corporate pioneers like SAS and Red Hat—has fostered a deeply interconnected ecosystem across biotechnology, software, cleantech, agtech, and advanced manufacturing. While the state’s primary R&D income tax credit (Article 3F) currently remains expired, active legislative efforts such as the NC Breakthrough Act (SB 354) indicate a strong political commitment to retroactively restoring and modernizing these incentives through 2040.

In the interim, North Carolina’s highly favorable sales and use tax exemptions (G.S. 105-164.13) for capital R&D equipment provide critical financial relief for scaling operations. Furthermore, recent state judicial rulings in McCabe and FSC II LLC have fortified taxpayer protections against administrative overreach by the NCDOR, ensuring that the legislative intent to foster innovation in the Triangle region remains intact. By aligning technical operations with strict federal documentation standards and leveraging state-level capital exemptions, companies in Raleigh can sustainably finance the next generation of industrial breakthroughs.

The information in this study is current as of the date of publication, and is provided for information purposes only. Although we do our absolute best in our attempts to avoid errors, we cannot guarantee that errors are not present in this study. Please contact a Swanson Reed member of staff, or seek independent legal advice to further understand how this information applies to your circumstances.