This comprehensive study details the United States federal and North Dakota state research and development tax credit requirements, specifically contextualized for the industrial landscape of Fargo, North Dakota. By examining statutory guidelines, recent case law, and the historical genesis of five distinct Fargo-based industries, this analysis provides an exhaustive framework for maximizing technological innovation incentives.

The Federal Statutory Framework of the R&D Tax Credit

The federal research and development tax credit, officially known as the Credit for Increasing Research Activities, was originally enacted by the United States Congress in 1981 to incentivize American businesses to invest in domestic technological innovation and maintain global competitiveness. Over the subsequent decades, the legislative architecture governing the classification, capitalization, and deductibility of research expenditures has evolved into a highly complex framework, governed primarily by Internal Revenue Code (IRC) Section 41 and the newly reformed IRC Sections 174 and 174A. To navigate this landscape successfully, corporate taxpayers must possess a nuanced understanding of statutory requirements, exclusionary provisions, and the paradigm-shifting impacts of recent federal tax reform.

The Section 41 Four-Part Test

To qualify for the federal R&D tax credit, a taxpayer’s underlying activity must satisfy a rigorous, concurrent four-part test as explicitly defined in IRC Section 41(d). The Internal Revenue Service (IRS) mandates that this test must be applied strictly at the “business component” level, meaning the criteria apply individually to every discrete product, process, computer software, technique, formula, or invention developed or improved by the taxpayer.

The first prong of this framework is the Section 174 Test, which dictates that the expenditures must be incurred in connection with the taxpayer’s active trade or business and represent research and development costs in the experimental or laboratory sense. Crucially, the IRS requires that technical uncertainty must be present at the exact outset of the project. The Treasury Regulations define this technical uncertainty as a state where the information available to the taxpayer does not establish the capability of developing or improving the business component, the method of developing it, or the appropriate design of the final component. If a company already possesses the knowledge to achieve the desired outcome without experimental deviation, the costs fail this fundamental threshold.

The second prong is the Discovering Technological Information Test, which requires that the research be undertaken for the primary purpose of discovering information that is fundamentally “technological in nature”. The IRS clarifies that the experimental process must fundamentally rely on the principles of the hard sciences, specifically the physical sciences, biological sciences, engineering, or computer sciences. Research based on the soft sciences, such as economics, sociology, psychology, or market research, is explicitly excluded from tax credit eligibility under this prong.

The third prong, known as the Business Component Test or the Permitted Purpose Test, mandates that the application of the research must be intended to be useful in the development of a new or improved business component of the taxpayer. The resulting improvement must relate to a new or enhanced function, performance, reliability, or quality. The statute explicitly states that research related solely to style, taste, cosmetic modifications, or seasonal design factors fails this permitted purpose requirement.

The final prong is the Process of Experimentation Test, which often serves as the most heavily audited aspect of an R&D claim. Under this requirement, “substantially all” of the research activities must constitute elements of a rigorous process of experimentation designed to evaluate alternatives and achieve a result where the capability or method was initially uncertain. The Treasury Regulations quantify “substantially all” as 80 percent or more of the core activity. The taxpayer must systematically identify the specific technical uncertainty, formulate one or more alternatives to eliminate that uncertainty, and conduct a process of evaluating those alternatives through modeling, advanced simulation, or a documented methodology of systematic trial and error.

Statutory Exclusions from Qualified Research

Even if an activity meets the four-part test, IRC Section 41(d)(4) expressly excludes several categories of research from the definition of qualified research. These exclusions are designed to prevent the subsidization of routine business operations and are the subject of intense scrutiny during IRS examinations.

The exclusion for research after commercial production bars any expenditures incurred after a business component has been readied for commercial release. This includes pre-production planning for a finished product, tool debugging, trial production runs, and routine quality control testing. Similarly, the statute excludes the adaptation of an existing business component to a particular customer’s requirement, as well as the duplication or reverse engineering of an existing product through physical examination or the review of blueprints.

Furthermore, computer software developed primarily for the taxpayer’s internal administrative functions, categorized as Internal Use Software (IUS), is statutorily excluded unless it satisfies an additional, highly stringent “High Threshold of Innovation” (HTI) test. The HTI test dictates that the internal software must be highly innovative, entail significant economic risk in its development, and not be commercially available for use by the taxpayer without substantial modification. In contrast, non-IUS software—which is developed to be sold, leased, licensed, or marketed to third parties—is subject only to the standard four-part test.

Finally, Section 41(d)(4)(H) excludes funded research, which is defined as research conducted to the extent it is funded by any grant, contract, or otherwise by another person or governmental entity. This exclusion requires contractors and engineering firms to carefully structure their agreements to ensure they retain financial risk and intellectual property rights, a dynamic that has sparked significant recent litigation.

The Paradigm Shift: Section 174, Section 174A, and the OBBBA of 2025

The legislative landscape governing research and experimental (R&E) expenditures shifted dramatically with the passage of the One Big Beautiful Bill Act (OBBBA), enacted on July 4, 2025. To understand the impact of the OBBBA, one must analyze the preceding tax regime established by the Tax Cuts and Jobs Act (TCJA) of 2017. Under the TCJA, beginning in tax year 2022, taxpayers were stripped of the ability to immediately deduct their R&E expenditures; instead, IRC Section 174 was amended to require the capitalization and amortization of all domestic R&E costs over 5 years, and all foreign R&E costs over 15 years.

The OBBBA fundamentally reversed this capitalization mandate for domestic operations by instituting a new statutory provision, IRC Section 174A, which reinstated and made permanent the immediate expensing of domestic R&E expenditures. Consequently, businesses conducting experimental research within the United States can now immediately deduct 100 percent of these costs in the tax year incurred, vastly improving corporate cash flow and providing a massive incentive for onshore development. Section 174A covers a broad spectrum of qualifying expenses, including employee salaries, patent fees, prototype models, schematic drawings, and related attorney’s fees incurred in the experimental sense.

However, the OBBBA deliberately retained the strict capitalization rules for offshore research. Under the post-OBBBA framework, foreign R&E expenditures remain trapped under IRC Section 174 and must be capitalized and amortized ratably over a 15-year period. This bifurcated treatment heavily penalizes offshore software development and international contract manufacturing, serving as a permanent structural incentive to relocate deep-tech innovation back to United States jurisdictions.

Additionally, the OBBBA provided critical transition rules for domestic R&E costs that were forcibly capitalized under the TCJA rules between the 2022 and 2024 tax years. Taxpayers are granted the option to deduct any remaining unamortized domestic R&E costs entirely in the 2025 tax year, or they may elect to split the deduction ratably across the 2025 and 2026 tax years. Small businesses, explicitly defined under the statute, were granted an even more aggressive retroactive election, allowing them to amend their 2022 through 2024 returns to immediately expense those costs retroactively. When utilizing these deductions alongside the Section 41 R&D tax credit, taxpayers must adhere to the limitations of IRC Section 280C(c), which dictates that any deduction taken under Section 174A must be reduced by the amount of the Section 41 credit claimed, unless the taxpayer explicitly elects to claim a reduced credit.

Federal Case Law and IRS Administrative Guidance

The interpretation of Section 41 and the classification of Section 174 expenditures are not static; they are constantly refined by the decisions of the United States Tax Court and binding administrative guidance issued by the Department of the Treasury and the Internal Revenue Service. Recent jurisprudence has fundamentally altered how taxpayers must structure their client contracts, substantiate their research activities, and format their refund claims.

Contractual Rights, Financial Risk, and Funded Research

For companies performing research on behalf of third parties—a scenario exceedingly common for industrial manufacturers, civil engineering firms, and software developers—the “funded research” exclusion represents the primary vulnerability during an IRS audit. Treasury Regulations stipulate that research performed for another party is only considered “unfunded” (and therefore eligible for the credit) if the research provider bears the financial risk of technical failure and retains substantial rights to the results of the research.

The parameters of financial risk and substantial rights were recently litigated in two landmark United States Tax Court cases: Smith et al. v. Commissioner (Docket Nos. 13382-17, 13385-17, and 13387-17) and System Technologies, Inc. v. Commissioner (Docket No. 12211-21). In Smith, an architectural design firm claimed Section 41 credits for complex structural engineering projects. The IRS aggressively sought summary judgment, arguing that the taxpayer’s research was funded because the firm only retained incidental “institutional knowledge” rather than formal intellectual property rights, and because payments were not explicitly contingent on the success of the research. The taxpayers countered that the IRS failed to identify any contractual clause divesting them of all substantial rights, and argued that the contracts implicitly required successful completion of design milestones before payment was issued, thereby shifting the financial risk to the firm.

The Tax Court ruled in favor of the taxpayers in both Smith and System Technologies, denying the IRS’s motions for summary judgment. The Court concluded that contracts utilizing milestone-based payments implicitly require the successful completion of the underlying research, thereby placing the financial risk squarely on the researcher. These pivotal rulings heavily influence how engineering firms must draft their master service agreements. This judicial interpretation is further supported by recent administrative guidance, specifically IRS Notice 2024-12 and its predecessor Notice 2023-63, which clarify that costs incurred by a research provider are considered valid specified research or experimental (SRE) expenditures if the provider bears the risk of financial loss related to failure and retains the right to use or exploit the resulting SRE product in its own trade or business.

The Shrinking-Back Rule and the Burden of Substantiation

When evaluating massive industrial projects, taxpayers frequently encounter situations where the overarching product does not meet the four-part test, but specific internal elements do. In these instances, taxpayers rely on the “shrinking-back rule” outlined in Treasury Regulation Section 1.41-4(b)(2). This rule allows the taxpayer, or a reviewing court, to apply the four-part test to progressively smaller sub-components until a qualifying technological element is identified.

However, the application of this rule requires an extraordinary level of granular documentation. In the influential Tax Court decision Little Sandy Coal Company, Inc. v. Commissioner, the Court reinforced the strict application of the shrinking-back rule in a heavy manufacturing context. The Court ruled against the taxpayer, determining that the company failed to produce sufficient contemporaneous evidence to apply the shrinking-back rule effectively at the sub-component level. The ruling emphasized that the burden of proof rests entirely on the taxpayer to produce detailed, employee-specific time allocations linked to exact sub-components. Similar precedent was established in Moore v. Commissioner, where the Court determined that the taxpayer failed to sufficiently document the activities of a key employee as directly supporting specific research activities. These cases underscore the danger of relying on high-level estimates or retrospective interviews, affirming that contemporaneous, granular documentation is a legal necessity.

Enhanced Refund Claim Stringency

In response to a surge in overly aggressive R&D tax credit claims, the IRS has instituted highly restrictive studying requirements for taxpayers filing refund claims. Stemming from Field Attorney Advice (FAA 20214101F) issued on October 15, 2021, the IRS established a rigid set of minimum information requirements for a claim to be considered valid.

Under these rules, a valid refund claim must exhaustively identify all business components to which the Section 41 claim relates for that specific tax year. For each identified business component, the taxpayer must detail all research activities performed, list every individual who performed those activities, and explicitly state the specific technological information each individual sought to discover. Furthermore, the taxpayer must provide a breakdown of total qualified employee wage expenses, supply expenses, and contract research expenses, culminating in a declaration signed under penalties of perjury. These strict evidentiary standards, which previously only applied to amended returns, have now been fully integrated into the updated IRS Form 6765 for the 2024 and 2025 tax filing seasons, forcing technology and life sciences companies to completely overhaul their internal tax compliance and documentation architectures.

The North Dakota State R&D Tax Credit (NDCC 57-38-30.5)

The North Dakota state research and experimental expenditure tax credit, codified under North Dakota Century Code (NDCC) 57-38-30.5, operates in parallel with the federal framework but is distinctly aggressive, designed specifically by the Legislative Assembly to attract and retain high-tech industrial sectors within the state. The statutory definition of “qualified research expenses” directly mirrors the language utilized in IRC Section 41(d), with one critical geographical constraint: the research and experimental activities must be conducted exclusively within the physical borders of the state of North Dakota. Research conducted offshore, or even in neighboring states, is strictly excluded from the state calculation.

Dual Calculation Methodologies

The North Dakota Office of State Tax Commissioner provides taxpayers with two distinct, highly lucrative methodologies for calculating the state R&D tax credit, both of which offer percentages that significantly outpace the federal baseline.

The first calculation option is the Regular Method. Under this approach, the credit is based on the volume of qualified research expenses incurred in North Dakota that exceed a historically established North Dakota base amount. The state awards an exceptionally generous 25 percent tax credit on the first $100,000 of excess qualified research expenses. For any excess qualified research expenses that surpass the initial $100,000 threshold, the state provides an 8 percent credit.

The second option, enacted to assist modern companies that lack decades of historical revenue data required to calculate the Regular Method base amount, is the Alternative Simplified Computation (ASC) Method, which became available beginning with the 2019 tax year. The state ASC method largely mirrors the mechanical structure of the federal ASC method, but at much higher statutory rates. Under the North Dakota ASC method, the credit equals 17.5 percent of the first $100,000 of alternative excess R&D expenses, plus 5.6 percent of the excess over $100,000. Taxpayers may elect to utilize the North Dakota ASC method regardless of whether they utilize the ASC method on their federal tax return.

Furthermore, North Dakota law contains a specific “startup” provision embedded within the ASC framework. If a taxpayer incurred zero qualified research expenses in any of the three preceding tax years, the North Dakota ASC credit for that current tax year is calculated as 7.5 percent of the first $100,000 of qualified research expenses, plus 2.4 percent of any qualified research expenses exceeding $100,000. Regardless of the calculation method chosen, any unused North Dakota research credits may be carried back three tax years and carried forward for up to fifteen consecutive tax years. For passthrough entities, the total credit is determined at the entity level and passed through to partners, shareholders, or members in proportion to their respective ownership interests, where it can be applied against individual state income tax liabilities.

The Small Business Transferability Provision

Perhaps the most unique and powerful mechanism within the North Dakota tax code is the credit transferability provision, specifically designed to address the cash-flow realities of early-stage deep-tech startups. The state legislature recognized that early-stage biotechnology, software, and AgTech companies often operate at a net loss for years to fund intense research, meaning they possess no immediate state income tax liability to offset with a non-refundable tax credit.

To bridge this gap, NDCC 57-38-30.5 allows certified primary sector businesses to directly monetize their credits. If a taxpayer—limited to an individual, C corporation, estate, or trust—first conducted qualified research in North Dakota after December 31, 2006, and generates gross annual revenues of less than $750,000, they are eligible for this program. If these criteria are met, the taxpayer may elect to sell, transfer, or assign up to $100,000 of their unused state R&D tax credits to another North Dakota taxpayer who has a tax liability.

This provision effectively transforms a deferred tax asset into immediate, non-dilutive working capital. The application process requires rigorous compliance; the selling entity must submit an application for certification to the North Dakota Department of Commerce Division of Economic Development and Finance, secure formal Primary Sector Certification, and provide a valid State Clearance Record Form and Property Tax Clearance Record Form to prove they are in good standing. Upon the execution of a transfer, the gross proceeds received by the transferor must be assigned as North Dakota income, and the Tax Commissioner retains a strict four-year statutory window after the date of the credit assignment to audit the returns of both the credit transferor and the purchaser to verify the legitimacy of the transaction.

The Industrial Genesis of Fargo, North Dakota

Fargo’s current status as a premier technological and research hub in the American Midwest is not a spontaneous occurrence; it is the direct, cumulative result of more than a century of industrial evolution. This evolution was initially driven by geographic necessity and severe environmental conditions, fostering a culture of entrepreneurial pragmatism that systematically matured from raw agricultural production into heavy mechanical manufacturing, and ultimately converged into advanced software, autonomous systems, and biotechnology.

The Foundation: Bonanza Farms and the Birth of Heavy Machinery

The economic DNA of the Red River Valley was forged in the second half of the 19th century through the phenomenon of “bonanza farms”. These were massive, highly commercialized wheat operations that dwarfed the typical 200-acre family farm of the era. The most prominent example was the Dalrymple Farm, an immense 11,000-acre operation located near Casselton, roughly 20 miles west of Fargo, which at one point was recognized as the largest cultivated farm in the world. The sheer scale of these tracts, combined with the heavy, flat clay soils of the Red River Valley, demanded relentless mechanical innovation; standard agricultural machinery built for the soft soils of the East Coast was entirely insufficient.

This absolute necessity birthed a formidable heavy manufacturing cluster in the region. In the mid-twentieth century, local inventor E.G. Melroe founded the Melroe Company in nearby Gwinner, North Dakota, successfully developing the world’s first skid-steer loader, which eventually evolved into the globally dominant Bobcat brand. Concurrently, during the 1950s, brothers Douglass and Maurice Steiger, operating out of a barn, began designing and welding massive articulated, four-wheel-drive tractors to handle their vast acreage. Recognizing the massive commercial demand for high-horsepower equipment, Steiger Tractor moved its primary manufacturing operations directly to Fargo in 1969. Under the strategic leadership of CEO Eugene Dahl, who previously served as an executive at Melroe, Steiger became a global vanguard in articulated heavy machinery. International Harvester acquired a stake in the 1970s, and the company was fully acquired by Case IH in 1986. Today, operating under CNH Industrial, the Fargo assembly plant remains one of the most advanced heavy manufacturing facilities on earth, consuming over 31,000 tons of raw steel annually to forge massive Case STX Steiger and New Holland tractors.

The Digital Bridge: From Mechanical Iron to Microchips

The critical transition from purely mechanical iron to advanced digital technology was initiated by local engineers seeking to optimize agricultural power output. Barry Batcheller, an in-house engineer at Steiger Tractor, achieved an industry milestone by successfully integrating the first computer chip into a commercial tractor. Realizing that the future of heavy industry lay in electronic controls, Batcheller departed to found Phoenix International in Fargo, a pioneering hardware and software manufacturing company specializing in ruggedized electronics for severe agricultural environments. The massive success of this venture led to its acquisition by John Deere in 1999, permanently anchoring deep-tech agricultural engineering within the Fargo metropolitan area.

While agricultural hardware was evolving, a parallel revolution was occurring in the enterprise software sector. In the 1980s, Great Plains Software emerged in Fargo, developing comprehensive accounting and business management solutions. Under the leadership of Doug Burgum, the company cultivated a massive, highly specialized pool of software engineering talent. In 2001, Microsoft Corporation acquired Great Plains Software for approximately $1.1 billion in stock. Rather than dissolving the location and moving the talent to the Pacific Northwest, Microsoft established the Great Plains Division as a core pillar of its Productivity and Business Services Group and maintained the massive Fargo campus. This strategic decision cemented Fargo as a critical node for software development, creating an ecosystem of highly skilled systems engineers and database architects who continually cross-pollinate with the region’s agricultural and manufacturing sectors.

The Modern Convergence: AgTech, UAS, and Biotechnology

Today, Fargo represents the advanced convergence of its historical strengths, heavily subsidized by forward-thinking state infrastructure investments and a specialized capital ecosystem that includes the state-owned Bank of North Dakota and the North Dakota Growth Fund.

The agricultural sector has evolved into “AgTech” and autonomous systems, physically manifested in the Grand Farm Innovation Campus. Located on 590 acres outside Fargo near Casselton, this initiative was established to facilitate hyper-collaboration between startups, massive corporations like Microsoft and Doosan Bobcat, and academic researchers. Featuring a 25,000-square-foot Innovation Shop and dozens of active field plots, the campus serves as a global testing ground for robotics and AI. The state heavily subsidizes this specific research vector; during the 2025 legislative session, the North Dakota Legislative Assembly passed Senate Bill 2256, a transformational act that appropriated $20 million directly to the North Dakota State University (NDSU) Research and Technology Park to specifically advance exploratory research and product development in “intelligent autonomous mobile equipment”.

Simultaneously, Fargo has become a national epicenter for aerospace and Unmanned Aerial Systems (UAS). Leveraging its uncongested airspace and flat terrain, North Dakota hosts the Northern Plains UAS Test Site, one of only seven FAA-approved testing centers in the United States. Expanding on this, the state launched Vantis, the nation’s first statewide UAS traffic management network. In an unprecedented move, Vantis operates a Federal Radar Data Enclave in partnership with the aerospace defense contractor Thales, allowing commercial drone operators secure, real-time access to unfiltered FAA radar data. This infrastructure makes North Dakota the premier location globally for testing autonomous Beyond Visual Line of Sight (BVLOS) flight operations, drawing aerospace engineers and defense startups to the Fargo region.

Finally, the region has cultivated a massive healthcare and biotechnology sector. Sanford Medical Center Fargo, an advanced 1-million-square-foot Level 1 Trauma center, serves as a clinical research hub, housing the 8AB Innovation Unit which develops and patents clinical technologies like AI-driven remote nursing platforms. Furthermore, NDSU’s robust biotechnology, microbiology, and pharmaceutical research programs have birthed massive commercial successes. The crown jewel of this sector is Aldevron, a Fargo-based biotechnology firm specializing in the manufacturing of plasmid DNA, RNA, and proteins essential for gene therapies and modern vaccines. After rapid expansion and the construction of its 250,000-square-foot Breakthrough Campus in south Fargo, Aldevron was acquired by Danaher Corporation for $9.6 billion, permanently establishing Fargo as a tier-one city for biomanufacturing and life sciences.

Five Unique Fargo Industry Case Studies

The following highly detailed case studies illustrate how specific industries operating within the unique ecosystem of Fargo, North Dakota, engage in complex engineering and software development activities that meet the rigorous standards of IRC Section 41 and NDCC 57-38-30.5. These scenarios demonstrate the practical application of the OBBBA immediate expensing rules, the resolution of statutory exclusions, and the capitalization of state tax incentives.

Agricultural Technology (AgTech) – Autonomous Soil Systems

Background: Valley Robotics LLC is an AgTech startup operating out of the newly constructed Grand Farm Innovation Shop near Casselton. Founded by former NDSU engineering students, the company is developing a fully autonomous, solar-powered rover designed to conduct continuous, deep-core soil sampling across the Red River Valley. The region’s heavy, moisture-retaining “gumbo” clay presents severe mobility and sensor-degradation challenges that commercial rovers designed in California cannot navigate.

The R&D Project: The company sought to develop a proprietary machine-learning algorithm integrated with a novel electro-hydraulic track-suspension system. The goal was to program the rover to dynamically adjust its internal weight distribution based on real-time soil moisture and traction slip data, preventing the rover from sinking in wet clay while maintaining enough concentrated downward force to extract a solid 12-inch soil core.

Application of the Four-Part Test:

1. Section 174 Test: High technical uncertainty existed at the project’s inception regarding whether the proprietary machine-learning algorithm could process real-time torque feedback with low enough latency to actuate the hydraulic suspension before total traction was lost in the mud.
2. Technological in Nature: The research process fundamentally relied on the principles of computer science (algorithmic logic and neural networks), mechanical engineering (electro-hydraulic suspension adjustments), and the physical sciences (soil mechanics and fluid dynamics).
3. Business Component: The development of an entirely new commercial product (the autonomous agricultural rover) intended for sale to large-scale farming operations.
4. Process of Experimentation: Valley Robotics engineered three distinct physical suspension prototypes. They first ran hundreds of simulated logic tests within the NDSU Research Park computing clusters to test the algorithm’s baseline assumptions. Subsequently, they conducted systematic trial-and-error field testing in the Grand Farm field plots. Engineers iteratively modified the algorithm’s feedback loops and the hydraulic actuator response times based on recorded failure rates in wet clay, documenting every iteration until the rover achieved a 95% continuous operational uptime.

Eligibility and Tax Impact: Because the research was conducted entirely within the physical borders of Fargo, the incurred costs qualify simultaneously for both federal and state R&D tax credits. Under the newly enacted 2025 OBBBA rules, Valley Robotics was able to immediately expense 100% of their domestic software development and mechanical engineering labor under IRC Section 174A, avoiding the restrictive 5-year amortization schedule imposed by the former TCJA rules. Furthermore, because their gross annual revenues are under the $750,000 statutory limit, they were able to monetize their North Dakota state credit through the small business transferability provision, selling the credit for non-dilutive cash to fund further prototyping.

Industrial Manufacturing – Heavy Agricultural Machinery

Background: Red River Implement Fabrication, a legacy heavy metals and fabrication manufacturer located in Fargo’s industrial park, serves as a tier-one supplier for major global agricultural equipment companies, tapping into the deep manufacturing heritage established by Steiger Tractor and Melroe. The company was contracted by a major OEM to design and cast a newly configured articulated steering joint for a next-generation, high-horsepower 4WD tractor designed specifically to pull ultra-wide, 100-foot air seeders.

The R&D Project: The OEM required an articulated joint that could handle a 20% increase in continuous torque stress without increasing the physical weight or volumetric footprint of the joint, which would otherwise require a total, multi-million dollar chassis redesign of the tractor. Red River Implement sought to develop a lighter, stronger joint utilizing a novel austempered ductile iron (ADI) casting process combined with a highly complex, 3D-printed internal honeycomb lattice structure.

Application of the Four-Part Test:

1. Section 174 Test: Severe uncertainty existed regarding whether the molten ADI casting could uniformly flow through and fill the intricate 3D-printed internal lattice without creating microscopic air pockets or micro-fractures during the rapid cooling phase.
2. Technological in Nature: The experimental work fundamentally relied on advanced metallurgy, thermodynamics, and mechanical engineering.
3. Business Component: The creation of an improved manufacturing process (the ADI lattice casting technique) and a new physical sub-component (the articulated joint).
4. Process of Experimentation: The engineering team utilized finite element analysis (FEA) software to model theoretical stress points across the lattice. They poured multiple test castings, systematically varying the cooling temperatures, pour rates, and alloy compositions. The resulting prototypes were subjected to destructive tensile and torsional testing in a laboratory environment, with the alloy mix adjusted iteratively based on the location of structural failures.

Eligibility and Tax Impact: The IRS routinely scrutinizes contract manufacturing under the “funded research” exclusion. However, relying on the recent legal precedents established in Smith and System Technologies, Red River Implement successfully documented that they bore the financial risk; their master service agreement dictated a fixed-price payment that was entirely contingent on the delivered joint passing the OEM’s 20% torque stress test. Furthermore, they retained substantial rights by patenting the proprietary internal lattice casting technique. Relying on the shrinking-back rule defined in Little Sandy, they meticulously documented the specific engineering hours dedicated solely to the joint, excluding the assembly of the wider tractor.

Aerospace and Unmanned Aerial Systems (UAS)

Background: Aethero Dynamics, a rapidly growing aerospace and defense startup operating near the Northern Plains UAS Test Site in Fargo, develops autonomous drone swarms for remote pipeline, powerline, and infrastructure inspection.

The R&D Project: To operate legally and safely over long distances under commercial regulations, Aethero needed to develop a proprietary “Detect and Avoid” (DAA) software architecture capable of interpreting massive streams of unfiltered, raw radar data pulled directly from the state’s Vantis/Thales radar enclave. The core objective was to program the drone swarm to autonomously alter their flight paths in unison to avoid unexpected crewed aircraft, without requiring any manual input from a ground-based pilot.

Application of the Four-Part Test:

1. Section 174 Test: Extreme technical uncertainty existed regarding the data latency of the secure radar stream and whether the drones’ onboard microprocessors could calculate an evasion vector faster than the physical closing speed of an incoming jet aircraft.
2. Technological in Nature: The project relied heavily on aerospace engineering, advanced physics, and complex computer science.
3. Business Component: A new software architecture integrated into an existing hardware component to provide a commercial service.
4. Process of Experimentation: The software engineers developed multiple predictive flight-path algorithms. They conducted systematic trial-and-error testing within the controlled Vantis BVLOS testing airspace. Utilizing controlled “intruder” aircraft flights coordinated by the test site, they measured the drone swarm’s reaction times, iteratively rewriting the latency-compensation code until the autonomous evasion maneuver achieved a 99.99% success rate without breaking swarm formation.

Eligibility and Tax Impact: Software development is heavily scrutinized under the Internal Use Software (IUS) exclusion. However, because Aethero’s software is physically embedded into a drone that is utilized to provide a commercial inspection service to third-party energy companies, it legally qualifies as Non-IUS, avoiding the stringent High Threshold of Innovation test. Under the 2025 OBBBA provisions, the massive software developer wage expenses were immediately expensed under IRC Section 174A, shielding the startup from punishing capitalization schedules.

Biotechnology and Life Sciences

Background: Dakota Bio-Therapeutics, a mid-sized biotechnology firm spun out of NDSU’s advanced microbiology research programs, specializes in the production of high-grade biologicals, specifically targeting the production of plasmid DNA utilized as a critical raw material in mRNA vaccine production, mirroring the success of local giant Aldevron.

The R&D Project: As global commercial demand scaled rapidly, Dakota Bio-Therapeutics faced a massive, crippling bottleneck in their downstream purification process. The firm sought to develop a completely novel continuous-flow chromatography process that would theoretically increase the yield of highly fragile supercoiled plasmid DNA by 30% while simultaneously reducing endotoxin contamination to negligible parts-per-billion levels.

Application of the Four-Part Test:

1. Section 174 Test: There was inherent scientific uncertainty regarding how the severe mechanical shear forces generated by the new continuous-flow industrial pumps would affect the structural integrity of the delicate DNA supercoils, potentially rendering the batch useless.
2. Technological in Nature: The research was fundamentally rooted in the biological sciences, biochemistry, and chemical engineering.
3. Business Component: An improved biological production process resulting in a higher-quality, higher-yield biological product.
4. Process of Experimentation: Scientists conducted a rigorous design of experiments (DoE) matrix on a small bench-scale level. They systematically varied fluid flow rates, buffer pH levels, and chromatography resin types. They analyzed the resulting DNA yield and structural integrity via mass spectrometry after each run, utilizing this data to slowly attempt scaling the optimal chemical combination up to an industrial-sized bioreactor.

Eligibility and Tax Impact: The scaling up of complex biological processes inherently involves experimental risks that fall squarely within the statutory definition of qualified research. To ensure compliance with the Section 41(d)(4) exclusion for research conducted after commercial production, the firm meticulously documented that only the laboratory bench costs and the initial validation runs of the industrial bioreactor were claimed as QREs; once the process was validated and standard production commenced, the associated costs were strictly excluded from the credit calculation.

Healthcare and Medical Devices

Background: CardioFargo Innovations, a specialized biomedical engineering firm focusing on the lucrative cardiovascular market, relocated to Horace, North Dakota to partner directly with clinical researchers at the Sanford Medical Center Fargo 8AB Innovation Unit.

The R&D Project: The company aimed to develop a highly flexible, micro-mapped electrophysiology (EP) catheter capable of navigating the incredibly complex geometries of the human left atrium to detect cardiac micro-arrhythmias with significantly higher resolution than current market offerings.

Application of the Four-Part Test:

1. Section 174 Test: Deep uncertainty surrounded the appropriate metallurgical composition of the micro-electrodes and the biocompatibility of the surrounding polymer casing when subjected to the severe, repeated bending radiuses required to navigate the human heart.
2. Technological in Nature: The project relied exclusively on biomedical engineering, materials science, and electrical engineering.
3. Business Component: The development of a highly advanced new medical device product.
4. Process of Experimentation: The engineering team developed multiple iterations of the polymer braiding. They evaluated these alternatives by physically pushing the prototypes through synthetic, fluid-filled anatomical models (in-vitro testing) to test torque response and trackability. They adjusted the material stiffness and braiding angle iteratively until the required flexibility was achieved without compressing the internal wires and compromising the electrical signal.

Eligibility and Tax Impact: Both the internal engineering labor dedicated to prototyping and the specific costs associated with controlled clinical trials conducted in partnership with Sanford Health constituted highly defensible qualified research expenses. Under the OBBBA, the firm immediately expensed the physical modeling costs and labor, while applying the North Dakota ASC method to maximize their state tax offset.

Strategic Compliance, Documentation Architecture, and Optimization

While the financial benefits generated by the federal OBBBA provisions and the North Dakota R&D tax credits are incredibly substantial, the modern regulatory environment is increasingly hostile to poorly documented, retrospective claims. The IRS’s rigid, unwavering enforcement of the FAA 20214101F studying mandates, combined with the Tax Court’s demand for sub-component level substantiation (as definitively established in Little Sandy), dictate that businesses operating in Fargo must adopt institutionalized, highly rigid tracking mechanisms.

Taxpayers can no longer rely on retrospective wage estimations or high-level project summaries. To survive a modern IRS or North Dakota Tax Commissioner audit, corporations must implement contemporaneous time-tracking software that mandates employees to log their hours not just to a generalized “project code,” but to specific, technical sub-components and discrete experimental tasks. Furthermore, narrative documentation—such as design iteration logs, laboratory test failure studies, version-controlled CAD drawings, and internal email correspondences detailing specific technical roadblocks—must be systematically archived to provide an undeniable paper trail proving that a systematic process of trial-and-error experimentation actually occurred.

Finally, in light of the new OBBBA legislation, companies must establish robust, permanent accounting firewalls to accurately segregate domestic R&E expenditures—which are highly valuable and eligible for Section 174A immediate expensing—from foreign R&E expenditures, which remain subject to the punitive Section 174 15-year amortization schedule. Failure to properly classify these expenses will result in disallowed deductions, compounding penalties, and the forfeiture of the very tax advantages that make Fargo such an attractive destination for innovation.

By aggressively, yet compliantly, utilizing the permanent immediate expensing provisions under the federal OBBBA of 2025, alongside North Dakota’s uniquely high-yielding state credits and cash-transferability provisions, companies operating in the Fargo ecosystem possess a profound, structural advantage in capital formation. Proper alignment of their day-to-day engineering and software development activities with the stringent realities of modern tax jurisprudence ensures that deep-tech innovation in the Red River Valley will continue to be heavily, and legally, subsidized by the federal and state tax codes.

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.