The Historical Foundation of Innovation in Winston-Salem, North Carolina

To rigorously analyze the application of modern tax incentives within a specific municipality, one must first understand the historical and economic infrastructure that fostered its industries. Winston-Salem, North Carolina, possesses a deeply rooted industrial history that has continuously evolved to meet the demands of the modern global economy. The region’s origins trace back to 1753 when the Moravians—a devout, highly progressive religious group originally from Eastern Europe—moved to central North Carolina seeking fertile soil, abundant water, and a temperate climate. They settled on a pristine, 100,000-acre tract they dubbed “Wachovia,” which today encompasses the vast majority of Winston-Salem and Forsyth County. The early Moravians were remarkably progressive for their era, adhering to a faith-based philosophy that mandated education for all individuals regardless of race or gender. This commitment to enlightenment culminated in the 1772 establishment of Salem Academy and College, recognized today as the country’s oldest educational institution for women. The Moravians required a central community for trade and church governing purposes, leading to the establishment of Salem in 1766, which rapidly became a sought-after trading post for specialized artists, craftsmen, and early manufacturers.

A mile north of Salem, the distinct town of Winston began taking shape in the mid-1800s, drawing its name from local legislator and Revolutionary War hero Joseph Winston. Winston quickly ascended as a regional leader in heavy manufacturing, buoyed exponentially by the twin economic engines of tobacco and textiles. With visionary business tycoons like R.J. Reynolds capitalizing on the tobacco trade and the Hanes family revolutionizing textile manufacturing, Winston exploded in both population and financial importance, effectively becoming the greatest industrial center in the Southeast United States by the turn of the twentieth century. Recognizing the inherent inefficiencies of operating two distinct municipal bureaucracies side-by-side, the two neighboring towns officially merged in 1913, pooling their vast resources to form the uniquely vibrant and uniquely hyphenated city of Winston-Salem. By 1919, Winston-Salem stood as the largest city in North Carolina, with a massive employment base dominated by the R.J. Reynolds Tobacco Company, J. Wesley Hanes Shamrock Hosiery Mills, and P.H. Hanes Knitting Company, all financially anchored by the Wachovia Bank and Trust Company.

However, as the American manufacturing landscape underwent a profound metamorphosis in the late twentieth and early twenty-first centuries—characterized by the offshoring of textile production and the domestic contraction of the tobacco industry—Winston-Salem faced a critical economic juncture. Rather than succumb to post-industrial decline, the city leveraged its deeply ingrained culture of innovation. Civic committees, academic institutions, and private developers initiated a master plan in the early 2000s to repurpose millions of square feet of former R.J. Reynolds tobacco warehouses and downtown factories. This visionary revitalization effort gave birth to the Innovation Quarter, one of the foremost urban technology parks in the United States. The district transformed historic, coal-fueled manufacturing plants into state-of-the-art wet laboratories, advanced biomanufacturing facilities, and collaborative corporate headquarters. Today, Winston-Salem has successfully transitioned from a traditional manufacturing hub into a modern landscape dominated by diverse companies specializing in healthcare, regenerative medicine, data science, food technology, and aerospace engineering. This continuous cycle of reinvention, characterized by a highly educated workforce and significant capital investment, makes Winston-Salem an optimal focal point for analyzing the application, maximization, and substantiation of federal and state Research and Development tax credits.

Industry Case Studies and Examples

The following section isolates five distinct industries deeply embedded in the Winston-Salem economy. For each sector, the historical development of the industry within the city is exhaustively analyzed, followed by an examination of specific, contemporary R&D activities and examples. Finally, a rigorous application of the United States federal and North Carolina state R&D tax credit requirements is provided to demonstrate precisely how these corporate entities could be eligible under the prevailing tax laws.

Case Study 1: Aerospace and Aviation Engineering

The history of aviation in Winston-Salem is a testament to the city’s ability to attract and nurture pioneering industries. The catalyst for this sector occurred in 1927, heavily inspired by Charles Lindbergh’s historic transatlantic flight, which prompted the city to hurriedly construct Miller Municipal Airport on leased land four miles north of downtown. The aviation sector truly took root through the financial investments and personal passion of Dick Reynolds, the oldest son and heir to the R.J. Reynolds tobacco fortune. Already an experienced pilot holding a license signed by Orville Wright, Reynolds established a branch of Reynolds Aviation in Winston-Salem in 1927, operating a fixed-base machine shop capable of overhauling advanced aircraft engines. In a pivotal shift for the local economy, a young aviation enthusiast named Tom Davis became deeply involved with the local aviation scene. In 1940, Davis brokered an arrangement with Dick Reynolds to purchase the struggling Camel City Flying Service for a mere $14,000, restructuring the company and officially incorporating it as Piedmont Aviation.

Under Davis’s leadership, Piedmont Aviation transformed from a regional repair facility into a commercial powerhouse. By January 1, 1948, Piedmont Airlines was formed as a division of the company, and on February 20, 1948, it completed its first scheduled passenger flight. Operating out of what became Smith Reynolds Airport, Piedmont Airlines grew into one of the most respected and profitable regional carriers in the United States, expanding its routes across the eastern seaboard and employing over 22,000 individuals before its eventual merger with USAir in 1989. This rich legacy of aircraft maintenance, meticulous overhaul procedures, and aviation business operations left Winston-Salem with a highly skilled, intergenerational aerospace workforce. Today, this legacy is continued by corporate giants like Collins Aerospace (an RTX business), which maintains a massive engineering and manufacturing presence in Winston-Salem specializing in the design of executive and VIP aircraft interiors and advanced seating systems.

Contemporary aerospace research and development in Winston-Salem is highly sophisticated. Collins Aerospace engineers and designs luxury business aircraft seating that must comply with incredibly strict aviation safety regulations. A specific R&D example involves the engineering, development, and dynamic crash testing of lightweight 16G and 21G aircraft seats. To reduce the overall weight of the aircraft and improve fuel efficiency, engineers experiment with novel thermoplastic composites and advanced additive manufacturing structures (3D printing) to create complex interior geometries.

Under the United States federal Internal Revenue Code (IRC) Section 41, this engineering activity aligns perfectly with the statutory requirements for the R&D tax credit. The financial expenditures related to designing a new 21G-rated seat structure are experimental costs designed to eliminate uncertainty regarding weight reduction and structural integrity under extreme gravitational forces, thereby satisfying the Section 174 requirement. The research relies fundamentally on the hard sciences of mechanical engineering, materials science, and the physics of kinematics during crash impacts, passing the “technological in nature” test. The newly designed VIP seat constitutes a tangible product held for sale to business jet manufacturers, satisfying the business component test. Finally, engineers utilize computer-aided design (CAD) simulations, finite element analysis (FEA), and physical dynamic sled testing to iteratively alter the seat’s structural nodes until it passes Federal Aviation Administration (FAA) safety requirements, establishing a clear process of experimentation.

Under North Carolina state law, specifically the historical Article 3F Research and Development tax credit, these exact engineering expenses would qualify for state-level subsidization. Because Collins Aerospace operates as a large corporate manufacturer, these expenditures would likely fall under the “Other Research Expenses” tier, yielding a state tax credit rate between 1.25% and 3.25% of qualified expenses. The primary state-level compliance hurdle for an aerospace firm of this magnitude would be substantiating the spatial location of the labor, proving definitively that the engineering design and dynamic testing occurred within the Winston-Salem facility rather than at other RTX global sites. Furthermore, to maintain eligibility under state law, the company must demonstrate adherence to North Carolina’s specific wage standards, provide comprehensive health insurance to its workforce, and maintain an exemplary environmental and Occupational Safety and Health Act (OSHA) compliance record.

Case Study 2: Regenerative Medicine and Biotechnology

The transition from a physical manufacturing economy to a highly specialized, knowledge-based economy in Winston-Salem is most vividly represented by the development of the biotechnology sector within the Innovation Quarter. Following the contraction of the domestic tobacco industry, civic leaders and academic institutions initiated a master plan in 2002 to create the Piedmont Triad Research Park. The definitive turning point for this initiative occurred in 2004 when Wake Forest University successfully recruited Dr. Anthony Atala from Boston Children’s Hospital to spearhead the newly formed Wake Forest Institute for Regenerative Medicine (WFIRM) in Winston-Salem. Dr. Atala and an initial team of approximately twenty researchers began their work in a few converted laboratory spaces on a single floor of the Richard H. Dean Biomedical Research Building. Over the subsequent two decades, WFIRM experienced exponential growth, eventually occupying the entirety of the five-story building and employing over 550 interdisciplinary physicians and scientists.

WFIRM cemented Winston-Salem’s reputation on the global scientific stage by becoming the first institution in the world to successfully engineer laboratory-grown organs (specifically, human bladders) that were implanted into living human patients. The presence of this massive academic and clinical research anchor spurred a vibrant biotechnology startup ecosystem in the surrounding downtown district, housing specialized companies focused on advanced biomanufacturing, cell therapies, and specialized tissue engineering. To support this, the Innovation Quarter continually acquires and retrofits historic structures, such as the recent acquisition of the 190,000-square-foot Linden Center, converting it into flexible laboratory and biomanufacturing space to meet regional demand for industry-ready infrastructure.

A premier example of the specific R&D activities occurring within this ecosystem is the development of microscopic 3D models of the human body, commonly referred to within the industry as “organs-on-a-chip”. Funded in part by the Defense Threat Reduction Agency, researchers at WFIRM utilize custom-built 3D bioprinters to print actual human cells and tissues representing the heart, liver, and lungs onto highly advanced microchips. This miniaturized system functions physiologically like a human body; the engineered heart tissue physically beats approximately sixty times a minute, while the liver tissue actively breaks down compounds. The primary goal of this research is to test the toxicity of experimental pharmaceutical drugs and hazardous environmental chemical vapors prior to human clinical trials, thereby accelerating the drug discovery process, lowering the cost of clinical trials, and drastically reducing the reliance on animal testing methodologies.

From a federal tax perspective under the United States IRC Section 41, the financial resources directed toward the development of the 3D bioprinting process and the unique bio-ink formulations constitute classic laboratory experimental expenditures. The activity is undeniably technological in nature, relying on the cutting-edge principles of cellular biology, biochemistry, pharmacology, and biomedical engineering. The “organ-on-a-chip” model represents both a novel process for testing drugs and a proprietary invention that can be licensed to major pharmaceutical companies, satisfying the business component requirement. The process of experimentation is rigorous and highly documented, requiring immense trial and error regarding cellular scaffolding matrices, nutrient delivery protocols, and bio-ink viscosity to ensure the fabricated micro-organs maintain viability over extended testing periods.

Under North Carolina state tax administration, this sector historically benefited most profoundly from the structure of the Article 3F tax credit. The state legislature intentionally designed the credit to encourage private sector commercialization of academic research. Therefore, biotechnology startups located within the Innovation Quarter that contracted with Wake Forest University to conduct collaborative research could claim the highly lucrative 20% “University Research” credit rate. Alternatively, startups engaging in internal research could qualify for the 3.25% “Small Business” or “Low-Tier” research rates, provided they met the underlying wage and health insurance requirements. Because regenerative medicine relies on strict, FDA-compliant laboratory protocols, documented clinical trials, and rigorous peer-reviewed methodologies, biotech firms in Winston-Salem are uniquely well-positioned to meet the strict contemporaneous documentation standards required by state and federal tax auditors.

Case Study 3: Data Science, Analytics, and Applied Artificial Intelligence

While Winston-Salem is globally recognized for physical manufacturing, its logistics, supply chain, and data science sectors possess equally deep and transformative roots. In 1980, local entrepreneur John Whitaker observed that the processing and settlement of manufacturer retail coupons was an incredibly inefficient, manual paper-based process that cost businesses significant time and capital. Addressing this market friction, Whitaker founded Carolina Coupon Clearing, introducing early digitization and technological processing to coupon settlement. This foundational business model allowed retailers to receive financial reimbursement exponentially faster while providing consumer brands with actionable data regarding marketing effectiveness.

Over the subsequent forty-five years, this Winston-Salem company evolved far beyond paper coupons, eventually rebranding as Inmar Intelligence. Today, Inmar employs over 4,500 people globally across the United States, Canada, Mexico, and India. Recognizing the value of the city’s urban revitalization, Inmar established its corporate headquarters within the Innovation Quarter, occupying a state-of-the-art, LEED Platinum-certified facility that once served as a primary R.J. Reynolds tobacco manufacturing plant. Inmar Intelligence has transformed into a premier data and tech-enabled services company, overseeing billions of dollars in digital commerce and leveraging Artificial Intelligence (AI) to optimize digital marketing, consumer loyalty programs, and highly complex healthcare supply chains.

A specific example of ongoing R&D within Inmar Intelligence involves the development of AI-enabled healthcare analytics and secure prescription return platforms. Inmar’s software engineering and data science teams conduct exhaustive research to build highly secure, regulatory-compliant technology architectures that support safe medication disposal and prescription return logistics for major hospital networks and pharmacies. This process requires the development of proprietary machine learning algorithms capable of processing massive, high-velocity datasets of pharmaceutical movements to predict supply chain bottlenecks, ensure strict compliance with Drug Enforcement Administration (DEA) regulations, and automate the complex financial reconciliation of expired pharmaceuticals between retail pharmacies and primary drug manufacturers. Additionally, through their partnership with GS1 US, their engineers develop systems to validate global product identifiers and UPC barcodes at scale, ensuring data integrity across the retail spectrum.

Applying the United States federal R&D tax credit requirements to software engineering requires careful legal navigation. The development of novel machine learning architectures to handle unique healthcare data streams involves significant computer science uncertainty, satisfying the Section 174 expense test. The work strictly relies on the principles of computer science and algorithmic data science, making it technological in nature. The resulting analytics platform serves as a distinct computer software product and service utilized by external healthcare organizations and retailers, satisfying the business component requirement. To resolve the inherent technological uncertainties, Inmar’s software engineers must systematically iterate, code, and test varying neural network models, database indexing schemas, and encryption protocols to achieve the required data processing speeds and cybersecurity standards, clearly constituting a process of experimentation.

Under North Carolina state law, the state’s approach to incentivizing software and digital media has historically been multifaceted. Inmar’s software development wages would easily qualify as standard research expenses under the general Article 3F provisions. However, North Carolina also offered highly specialized tax incentives for digital software development, such as the Interactive Digital Media Tax Credit (codified under G.S. 105-129.56). While this specific credit was heavily utilized by video game engine developers (such as Epic Games), advanced interactive software platforms that provided dynamic, data-driven user experiences frequently explored eligibility under broader digital media statutes, highlighting the state government’s fluctuating but supportive approach to subsidizing high-tech software development. Although the Interactive Digital Media credit officially sunset in 2014, the North Carolina Department of Revenue continued to process significant carryforward returns for this credit as recently as calendar year 2024, demonstrating the long-term financial lifecycle of state-level tax planning strategies.

Case Study 4: Food Science and Automated Manufacturing Systems

The culinary and food manufacturing sector of Winston-Salem is famously and inextricably anchored by Krispy Kreme Doughnuts. The company’s origin traces back to 1933 when Vernon Rudolph began selling yeast-raised doughnuts in Paducah, Kentucky, utilizing a highly secretive recipe that his uncle had purchased from a New Orleans French pastry chef named Joe LeBeau. Seeking a larger and more robust consumer market, Rudolph relocated the operation to Winston-Salem in the summer of 1937. Historical sources indicate Rudolph was drawn to the city by the booming economic engine of the local tobacco industry, correctly reasoning that a prosperous, highly concentrated industrial workforce running shift-work would readily support a secondary consumer goods market for hot, fresh baked goods.

Rudolph initially rented a building in the Historic Old Salem district, focusing on selling his product wholesale to local grocery stores. However, the sweet aroma of the baking process attracted pedestrians directly to the bakery, prompting Rudolph to physically cut a hole in the building’s exterior wall to sell hot doughnuts directly to consumers. As the company rapidly expanded across the Southeast in the 1940s and 1950s, Rudolph realized that maintaining the unique texture, taste, and consistency of the product across multiple franchise locations required extreme standardization. Consequently, Krispy Kreme evolved from a simple bakery into a heavy industrial manufacturer. The company built a central mixing plant in Winston-Salem to develop consistent dry dough formulations and hired mechanical engineers to design, patent, and manufacture their own proprietary, automated doughnut-making equipment. Despite a brief period of corporate ownership under Beatrice Foods in the 1970s, the company returned to its independent roots and went public in 2000. Today, Krispy Kreme continues to invest heavily in advanced manufacturing and processing, recently announcing a $5.8 million capital investment to expand the production of its Branded Sweet Treats line at its Winston-Salem facility.

The contemporary R&D activities at Krispy Kreme’s 105,000-square-foot Winston-Salem headquarters span two distinct scientific disciplines: mechanical automation engineering and chemical food science. Mechanically, internal engineers collaborate with external automation partners, such as Think PLC, to integrate highly advanced Siemens programmable logic controllers (PLCs) and digital drives into their proprietary manufacturing equipment. This equipment includes high-precision extruders, the famous “glaze waterfall,” and complex vertical cooling conveyors. Chemically, the company’s food scientists and quality assurance teams experiment extensively with complex dough enhancers and non-microbial food hazard controls. This includes the industrial application of techniques similar to the “tzanghong” (water roux) method—a process of gelatinizing starches in a liquid medium to trap maximum moisture, ensuring the doughnut remains exceptionally soft, airy, and stable over an extended shelf-life without premature staling.

Under the United States federal R&D tax credit guidelines, these activities require nuanced substantiation. Routine culinary recipe testing for flavor profiles alone does not qualify for the credit; however, the work conducted at Krispy Kreme addresses hard scientific uncertainties regarding chemical stability and mechanical manufacturing scalability. Expenses incurred to design a new automated extrusion nozzle capable of handling high-viscosity dough or formulating a new chemical moisture preservative are strictly experimental. The R&D relies on mechanical engineering for the equipment and food science, chemistry, and microbiology for the yeast fermentation and starch gelatinization processes. The resulting R&D yields both an improved automated manufacturing process and an improved physical product. The process of experimentation involves food scientists conducting iterative batch testing, measuring precise variables such as dough viscosity, exact fermentation resting times, and the sheer stress applied to the dough during mechanical extrusion, systematically rejecting failed formulations until strict safety, quality, and shelf-life parameters are met.

Under North Carolina state law, Krispy Kreme’s manufacturing equipment design and chemical testing wages would have qualified for standard research credits under Article 3F. Furthermore, as a legacy manufacturing facility, the company benefits from a broad spectrum of localized economic incentives. The City of Winston-Salem and Forsyth County recently approved substantial performance-based financial incentives to support Krispy Kreme’s facility expansion, reflecting the local government’s deep commitment to retaining and growing advanced food processing operations within the municipal boundaries.

Case Study 5: Advanced Textiles and Polymer Material Sciences

The textile industry is intrinsically linked to the cultural identity and historical wealth of Winston-Salem. Operating in tandem with the tobacco industry, textiles formed the backbone of the region’s early twentieth-century economic dominance. In 1901, industrialist John Wesley Hanes founded the Shamrock Mills company specifically to manufacture men’s hosiery, while his brother, Pleasant Henderson Hanes, founded the P.H. Hanes Knitting Company to mass-produce men’s underwear. These highly successful enterprises eventually consolidated their operations and evolved over decades into Hanesbrands, a global apparel manufacturing behemoth headquartered in Winston-Salem.

While traditional cut-and-sew textile manufacturing largely migrated to offshore facilities in the late twentieth century due to labor cost differentials, the highly technical and scientific aspects of the industry—specifically textile engineering, polymer science, and advanced material research and development—remained firmly localized in North Carolina. Winston-Salem serves as the central brain trust for Hanesbrands, where corporate R&D teams constantly explore emergent technologies in fabric construction, low-impact chemical dyeing processes, and synthetic fiber blends to respond rapidly to shifting global consumer demands for high-performance, sustainable apparel.

A prime example of Hanesbrands’ ongoing R&D involves the engineering of performance fabrics, such as their recent introduction of “SuperSoft” material innovations and advanced thermal regulation garments designed for athletic wear. This R&D is highly scientific and quantitative, frequently involving direct, collaborative partnerships with North Carolina State University’s Wilson College of Textiles. Corporate engineers and academic researchers utilize advanced facilities like the Textile Protection and Comfort Center (TPACC) to prototype complex materials, such as a novel three-layer fleece. The prototyping process involves extensive experimental knitting, sanding, and calendaring of synthetic fibers. These prototype materials are then subjected to rigorous stress testing utilizing MTS criterion machines and automated abrasion testers to precisely quantify thermal heat retention, moisture-wicking capabilities, and overall tensile strength under extreme physical wear.

Applying the United States federal tax laws to this scenario, the financial expenditures related to developing new synthetic polymer blends that increase thermal wicking without compromising structural fabric integrity constitute qualified experimental costs. The research is deeply rooted in the physical sciences, specifically polymer chemistry, materials science, and textile engineering, satisfying the technological in nature requirement. The resulting proprietary fabric represents a new product and chemical formula held for commercial sale by Hanesbrands. The process of experimentation is highly structured; engineers systematically isolate and test individual variables such as thread count density, polymer extrusion melt temperatures, and chemical dye adhesion rates, followed by rigorous quantitative testing in controlled environmental chambers to validate hypotheses regarding the fabric’s cooling metrics.

Under North Carolina state law, Hanesbrands’ R&D framework provides a perfect example of how corporations maximized the Article 3F credit structure. Because Hanesbrands frequently partners directly with local academic institutions like NC State University for senior design capstone projects, material lab testing, and joint patent development, the financial expenditures paid to the university for this scientific testing would have qualified for the highly advantageous 20% North Carolina University Research credit rate. This specific provision was a cornerstone of North Carolina’s economic policy, designed to directly funnel corporate capital into the state’s public university system, thereby subsidizing higher education while simultaneously keeping the resulting intellectual property and commercialized manufacturing operations anchored within the state’s borders.

Detailed Analysis of United States Federal R&D Tax Credit Administration

To fully comprehend the tax landscape for Winston-Salem industries, a granular analysis of the United States federal statutory framework and its current administrative enforcement mechanisms is required. The federal Credit for Increasing Research Activities, permanently codified under Internal Revenue Code (IRC) Section 41, was established by Congress to encourage domestic businesses to invest long-term capital into innovation, thereby ensuring the United States remains highly competitive in the global market. Generally calculated as 20% of qualified R&D spending that exceeds a historically established base amount, the credit mandates that the qualifying labor must be physically performed within the borders of the United States.

The Federal Four-Part Test

For any corporate activity to be legally deemed “Qualified Research,” it must strictly and simultaneously satisfy the “Four-Part Test” outlined in IRC Section 41(d). The Internal Revenue Service (IRS) mandates that this test must be applied separately to each specific “business component” of the taxpayer, rather than to the company’s overall operations.

The Impending Mandatory Use of IRS Form 6765 Section G

The most disruptive administrative change to the federal R&D tax credit in a generation is currently underway regarding the revision of IRS Form 6765, Credit for Increasing Research Activities. Historically, taxpayers could calculate and report their Qualified Research Expenses (QREs) in the aggregate, effectively providing the IRS with a single, consolidated sum of employee wages, consumable supplies, and third-party contractor costs on their tax returns.

However, following internal guidance issued in 2021 through Chief Counsel Memorandum (CCM) 20214101F, the IRS signaled a severe administrative crackdown on vague or poorly documented R&D claims, particularly amended refund claims. The newly revised draft of Form 6765 includes an entirely new section known as “Section G” (Business Component Detail), which is slated to become legally mandatory for tax year 2025. Section G radically alters the reporting landscape; it requires taxpayers to deconstruct their aggregate QREs and mathematically map them directly to specific business components.

For a major Winston-Salem corporation like Collins Aerospace or Inmar Intelligence, they can no longer simply claim a multi-million dollar credit for the aggregate wages of their “Engineering Department” or “IT Department.” Under the strict new Section G rules, they must list every individual seating design project or specific software module they developed. For each distinct business component, the taxpayer must detail the specific scientific uncertainties faced, describe the iterative experimental process used to resolve them, list the specific individual employees who executed the work, and detail exactly what information each employee sought to discover. This administrative change shifts the burden of proof heavily onto the taxpayer’s internal project management and time-tracking software. Failure to maintain highly granular, contemporaneous records mapping individual employee hours to specific technological uncertainties will result in the summary dismissal of the claim by the IRS.

Detailed Analysis of North Carolina State R&D Tax Credit Administration

While Winston-Salem businesses heavily utilize the federal credit, the state-level tax environment in North Carolina has historically been a major driver of localized economic development, despite recent legislative expirations and conformity complexities.

The Article 3F Statutory Framework

Historically, North Carolina offered a highly lucrative and deeply structured state-level incentive under Article 3F (G.S. 105-129.55), officially known as the North Carolina Research and Development Tax Credit. While the general provisions of this specific credit sunset for expenses incurred after December 31, 2015, examining its framework remains critical for entities engaged in ongoing NCDOR audits, the utilization of massive carryforwards (as unused Article 3F credits could be carried forward for fifteen succeeding years), and preparation for potential legislative reenactments, such as the heavily debated Senate Bill 354, which remains in committee.

When actively generating new credits, the North Carolina statute cleverly utilized the established federal definitions of qualified research under IRC Section 41, ensuring businesses did not have to perform two entirely different scientific capability assessments. However, the state imposed additional, strict socio-economic eligibility criteria to ensure the tax benefits actively improved the standard of living for North Carolina residents. To be eligible, taxpayers were required to meet specific localized wage standards, provide subsidized health insurance for their employees, maintain an exemplary environmental record, and adhere strictly to Occupational Safety and Health Act (OSHA) standards without severe violations.

Unlike the federal credit, which relies on a highly complex base-amount calculation comparing current spending to historical gross receipts, the North Carolina credit provided a straightforward tiered percentage calculation based on the specific classification of the research and the size of the entity.

Taxpayers were strictly prohibited from “double-dipping”; if a specific expense qualified for multiple categories (e.g., a small business conducting university research), the taxpayer was only permitted to take the credit at the highest applicable percentage rate. Eligible businesses claimed the credit by filing Form NC-478I with the North Carolina Department of Revenue (NCDOR), electing to apply the credit against either their corporate franchise tax or state income tax liabilities.

Alternative State Incentives and Federal Conformity Issues

Beyond the traditional R&D credit, North Carolina utilized highly specialized tax mechanisms to foster targeted industries within hubs like the Innovation Quarter. For instance, the Interactive Digital Media Tax Credit (G.S. 105-129.56) was designed to subsidize the creation of complex software and gaming engines. Although this specific provision sunset for new generation in 2014, the NCDOR’s 2025 Economic Incentives Report demonstrates that millions of dollars in residual credits, including those for Historic Rehabilitation (Article 3D) and Mill Rehabilitation (Article 3H), are still actively being processed and claimed by taxpayers as they renovate the physical infrastructure of Winston-Salem’s downtown.

A highly critical administrative nuance currently affecting Winston-Salem businesses is the state’s disjointed timeline for conforming to the federal Internal Revenue Code. For the 2025 tax year, the NCDOR issued binding guidance noting that North Carolina had only legally conformed to the federal IRC as it existed on January 1, 2023. Consequently, any federal tax legislation enacted by Congress after that date—such as changes to bonus depreciation schedules, Section 163(j) interest limitations, and crucially, the Section 174 R&E capitalization and amortization rules enacted under the Tax Cuts and Jobs Act—must be explicitly excluded when calculating North Carolina state taxable income. This legislative lag requires corporate tax departments to maintain two completely distinct sets of financial books: one calculating federal taxable income under the current federal law, and one recalculating income strictly under the outdated 2023 federal framework for state purposes, a burden that persists until the North Carolina General Assembly passes an updated conformity bill.

Federal and State Case Law Jurisprudence

The intersection of Winston-Salem’s dynamic, multi-sector industrial base and the current tax regulatory environment presents a highly complex legal landscape. Federal and state courts have recently issued rulings that drastically reshape how corporate financial officers and legal counsel must substantiate their innovation activities.

Federal Jurisprudence: Process, Timing, and Funding

The federal courts have increasingly sided with the IRS in demanding exceptionally high levels of contemporaneous documentation to satisfy the IRC Section 41 requirements. The landmark 2021 Tax Court decision in Little Sandy Coal Co., Inc. v. Commissioner established a strict legal precedent regarding the “Process of Experimentation” test. The court explicitly ruled that taxpayers must quantitatively prove that at least 80% of their total research activities followed a structured, scientific process of experimentation. Generalized claims of engineering work are insufficient; companies must produce physical or digital logs showing hypothesis formulation, testing metrics, and design iterations.

Furthermore, the 2024 ruling in Phoenix Design Group, Inc. v. Commissioner heavily scrutinized the timing of when technological uncertainty is identified. The Tax Court ruled against the engineering firm because it failed to explicitly identify the specific technological uncertainties before beginning the research. For a Winston-Salem manufacturer like Krispy Kreme or Collins Aerospace, this means that before a team of engineers begins tweaking a machine or designing a seat, they must produce contemporaneous documentation explicitly stating the engineering problem to be solved. Vague, post-hoc justifications of “design challenges” written months after the project is completed will result in immediate credit disallowance under the new IRS enforcement paradigms.

Additionally, the 2024 Meyer, Borgman & Johnson, Inc. v. Commissioner case serves as a stark warning regarding the mechanical administration of refund claims. The court upheld the IRS’s use of a new automated “Classifier” review system to summarily deny an R&D tax credit refund claim before it even reached a specialized human examiner, simply because the initial documentation package lacked the required granularity regarding business components and employee wage mapping.

For professional services firms, contract engineers, and custom manufacturers in Winston-Salem, the “Funded Research Exclusion” under IRC Section 41(d)(4)(H) remains the most heavily litigated statutory provision. The IRS aggressively targets companies that perform R&D on behalf of third-party clients, arguing the research is ineligible. However, taxpayers secured vital victories in the recent 2025 Tax Court cases Smith v. Commissioner and System Technologies, Inc. v. Commissioner. In these cases, the IRS moved for summary judgment to deny the credits, arguing the taxpayers were merely performing standard professional services and that their clients “funded” the research via contract. The Tax Court denied the IRS’s motions, ruling that determining “funding” requires an exhaustive review of the underlying legal contracts. To survive an IRS audit, a Winston-Salem contractor must ensure their client agreements explicitly demonstrate two factors: first, they must bear the economic risk (payment must be strictly contingent on the success of the research), and second, they must retain substantial intellectual property rights to the research results, allowing them to utilize the underlying engineering in future projects without paying a license fee to the original client.

State Jurisprudence: Sovereignty and Administrative Exhaustion

While North Carolina’s primary R&D credit is sunset, disputes regarding historical claims, multi-year carryforwards, and alternative state-level credits highlight a critical aspect of state tax litigation and the balance of power between taxpayers and the NCDOR.

In a landmark decision involving North Carolina renewable energy tax credits, a state court firmly rebuked the NCDOR for attempting to import federal tax law concepts to deny a state-level tax credit. The judge explicitly held, reinforcing the precedent set in the Fidelity Bank case, that federal IRS authorities, internal memos, and guidelines are not controlling over North Carolina statutory law unless explicitly incorporated by the state’s General Assembly. This ruling represents a massive victory for corporate taxpayers, as it effectively prevents the NCDOR from utilizing stringent federal IRS audit manuals or restrictive federal case law to retroactively narrow the scope of state-level economic incentives during an audit.

Finally, the procedural mechanics of challenging the NCDOR are strictly governed by state law. As demonstrated in the North Carolina Business Court case involving Monarch, taxpayers must strictly adhere to the state’s administrative procedures. If a Winston-Salem corporation wishes to challenge the NCDOR’s denial of an R&D or rehabilitation tax credit—even if the challenge involves constitutional claims regarding the state’s tax policy—the taxpayer must fully exhaust all administrative remedies through the agency and the administrative law judge before the judicial branch will consider the case ripe for review.

Final Thoughts

The municipality of Winston-Salem, North Carolina, represents a profound microcosm of American industrial and economic evolution. From its highly progressive origins as a Moravian educational and trade settlement to its twentieth-century dominance in global tobacco and textile manufacturing, and finally to its modern renaissance as a premier hub for biotechnology, aerospace engineering, and data science, the city’s economic survival has always depended on relentless, well-capitalized innovation.

As exhaustively demonstrated by the operations of Collins Aerospace, the Wake Forest Institute for Regenerative Medicine, Inmar Intelligence, Krispy Kreme Doughnuts, and Hanesbrands, the complex scientific and engineering activities occurring daily within Winston-Salem fit squarely within the legislative intent of both the United States federal and historical North Carolina state Research and Development tax credits. These corporations are actively resolving technological uncertainties across the fields of mechanical engineering, polymer chemistry, computer science, and cellular biology.

However, the regulatory and judicial environment governing these financial incentives has never been more rigid or demanding of the corporate taxpayer. The IRS’s implementation of strict Business Component documentation mandates under the revised Form 6765 Section G, combined with aggressive federal litigation regarding the Process of Experimentation (Little Sandy Coal), the precise timing of technological uncertainty identification (Phoenix Design Group), and the nuances of the Funded Research Exclusion (Smith and System Technologies), demands that corporations drastically elevate their internal R&D tracking systems. Simultaneously, corporations must expertly navigate the complexities of state-level tax conformity and procedural exhaustion. To maximize and legally secure these highly lucrative incentives, Winston-Salem’s innovators must treat the legal, contractual, and financial substantiation of their research with the exact same level of precision, rigor, and documentation as the underlying scientific research itself.

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.