In-house research expenses within the North Dakota R&D tax credit represent the direct internal costs—specifically qualifying employee wages, research supplies, and computer usage fees—incurred during innovative activities performed physically within state borders. These expenditures serve as the foundational dollar-for-dollar base used to calculate a nonrefundable credit against North Dakota’s income tax liability.

A more granular analysis reveals that these expenses are not merely accounting line items but are the statutory engines of the state’s Research and Experimental Expenditure Tax Credit, codified under North Dakota Century Code (N.D.C.C.) § 57-38-30.5. While the state utilizes the federal definitions of “qualified research” and “qualified research expenses” (QREs) as established in the Internal Revenue Code (IRC) Section 41, it applies a rigid geographic filter that mandates all qualifying activities must be conducted “within the state” to be eligible. This localized restriction transforms the federal broad-based incentive into a state-specific economic tool designed to anchor high-tech employment and intellectual property development within the North Dakota economy. For a business to successfully claim these expenses, it must navigate the complexities of “perpetual federalization”—where state law automatically updates with federal code changes—while maintaining a meticulous audit trail that isolates North Dakota-sourced costs from global R&D operations.

The Legislative and Regulatory Foundation of North Dakota R&D

The North Dakota Research and Experimental Expenditure Tax Credit is an enduring feature of the state’s tax landscape, designed to incentivize businesses to invest in technological discovery and process improvement. Understanding the meaning of in-house research expenses requires first understanding the statutory architecture that governs the credit’s application across different tax entities and historical periods.

Evolution of N.D.C.C. § 57-38-30.5

The credit was originally enacted in 1987 via House Bill No. 1645, patterned after successful models in neighboring jurisdictions to encourage North Dakota corporations to undertake risky development projects. Over the decades, the credit has undergone several structural shifts, most notably in 2007, when it was expanded to include passthrough entities such as S corporations and partnerships, and again in 2019, with the introduction of the Alternative Simplified Computation (ASC) method.

The current law allows the credit against taxes imposed under section 57-38-30 (Corporate Income Tax) or 57-38-30.3 (Individual Income Tax). This dual applicability ensures that both large industrial manufacturers and small technology startups can benefit from the incentive, provided their research occurs within the state’s geographic boundaries.

Geographic Sourcing: The “Within the State” Requirement

The most critical distinction between federal R&D credits and North Dakota’s version is the geographic nexus. N.D.C.C. § 57-38-30.5(1) explicitly states that the credit is for “conducting qualified research in this state”. This requirement applies with equal force to both the “qualified research expenses” and the “base amount” calculation.

Administrative Code 81-03-05.1-06 provides specific guidance on this sourcing, clarifying that when calculating the credit, a taxpayer may include in the base amount only those amounts that were incurred in or are attributable to North Dakota. This creates a high evidentiary burden for companies with multi-state operations. For in-house expenses, this means that even if a researcher is working on a project that benefits a North Dakota plant, their wages cannot be included if the work is physically performed at a lab in Minnesota or via a remote home office in South Dakota.

Deconstructing In-House Research Expenses

Following the federal guidance in IRC § 41(b)(2), which North Dakota adopts by reference, in-house research expenses are categorized into three primary buckets: wages, supplies, and computer usage costs. To be qualifying, these must be paid or incurred “in carrying on any trade or business of the taxpayer”.

Qualified Wages and the “Substantially All” Rule

Wages typically represent the majority of any R&D claim. Under the North Dakota framework, “wages” are defined according to IRC § 3401(a), generally encompassing all remuneration for services performed by an employee for their employer, including the amount reported in Box 1 of the employee’s Form W-2.

To qualify as an in-house research expense, wages must be paid for “qualified services,” which are defined as:

1. Engaging in Qualified Research: Direct performance of the research activities.
2. Direct Supervision: Managing the researchers and technical processes involved in the experimentation.
3. Direct Support: Activities that assist the research, such as lab cleanup, data entry, or prototype fabrication.

A taxpayer-friendly provision known as the “80% Rule” or “Substantially All Rule” allows a company to include 100% of an employee’s wages in the credit calculation if at least 80% of that employee’s services for the year were qualified research services. If the time spent is less than 80%, only the actual percentage of wages attributable to R&D may be claimed. In a North Dakota context, this rule is only applicable to time spent performing those services within North Dakota.

Research Supplies

Supplies constitute any tangible property used in the conduct of qualified research, provided the property is not land, improvements to land, or property subject to the allowance for depreciation. In North Dakota’s diverse economy, research supplies can vary significantly by industry:

• Agriculture: Specialized seeds, chemicals, or fertilizers used in experimental test plots.
• Manufacturing: Raw materials consumed in the creation of experimental prototypes or “first-of-a-kind” tooling.
• Energy: Materials used in testing new extraction methods or carbon capture technologies.

A key requirement is that these supplies must be “used in the conduct of qualified research.” General administrative supplies or items used in routine quality control (which is specifically excluded by IRC § 41(d)(4)) do not qualify as in-house research expenses.

Rights to Use Computers (Cloud and Hosting)

In the modern digital economy, the “right to use computers” increasingly refers to cloud computing and hosting costs. IRC § 41(b)(2)(A)(iii) allows for the inclusion of amounts paid to another person for the right to use computers in the conduct of qualified research.

This is a vital expense for North Dakota’s growing software and data science sectors. However, there are two strict limitations:

1. Double Benefit Exclusion: The taxpayer cannot claim the expense if they receive any payment from another person for the right to use substantially identical property (preventing companies from subleasing server time and claiming the original cost).
2. Sourcing Location: The Office of State Tax Commissioner requires that the research directing the use of the computer be conducted in North Dakota. While the cloud server itself may be located elsewhere, the engineers accessing that power and conducting the simulations must be physically located in North Dakota for the expense to be North Dakota-sourced.

Computation Methods and Sourcing Impact

The value of North Dakota’s in-house research expenses is unlocked through one of two primary calculation methods. The choice of method can significantly alter the “meaning” of an expense by changing how much of that expense is ultimately translated into a tax credit.

The Regular Incremental Method

The regular method rewards companies for increasing their R&D spend relative to their historical “base amount.” Under this method, North Dakota offers a tiered credit rate structure that is highly competitive on a national scale.

For example, if a company has $500,000 in North Dakota in-house research expenses and a base amount of $300,000, the “excess” is $200,000. The resulting credit would be $33,000 (calculated as 25% of the first $100,000 plus 8% of the next $100,000).

A critical component of the regular method is the “50% Base Amount Rule.” North Dakota law, mirroring federal standards, dictates that the base amount can never be less than 50% of the current year’s qualified research expenses. This ensures that the credit remains an “incremental” incentive rather than a blanket subsidy for all R&D.

The Alternative Simplified Computation (ASC) Method

For tax years beginning after 2018, North Dakota adopted the ASC method, which provides an alternative for companies that may lack historical data or have fluctuating R&D budgets.

Under the ASC method, the credit is based on “alternative excess research and development,” defined as the current-year QREs exceeding 50% of the average QREs for the three preceding tax years.

If a taxpayer has zero qualified research expenses in any of the three preceding years, the credit is simplified to 7.5% of the first $100,000 and 2.4% of the amount over $100,000 of the current year’s expenses.

Sourcing Challenges and the Remote Workforce

The transition to remote and hybrid work has introduced unprecedented complexity into the calculation of North Dakota in-house research expenses. Because the state requires the research to be “done within the state,” the physical location of the employee at the moment of performance is the ultimate arbiter of eligibility.

The “Nexus” and Withholding Intersection

North Dakota generally imposes wage withholding obligations on employers that maintain an office or derive income in the state. However, the sourcing of wage income for the R&D credit follows a stricter “location of performance” rule rather than a “convenience of the employer” test.

If an employee is a resident of Minnesota but commutes to a lab in Fargo, ND, their wages are North Dakota-sourced and eligible for the credit. However, if that same employee works from home in Moorhead, MN, those wages are sourced to Minnesota and are disqualified from the North Dakota R&D credit calculation. Businesses must implement robust time-tracking and geographic-tagging systems to ensure they only include wages for hours physically worked inside North Dakota state lines.

Cloud Computing and Remote Access

The sourcing of “computer usage” expenses in a remote environment is equally nuanced. While the cloud servers used for R&D may be global, the “conduct” of the research occurs where the user is located. If a researcher in Bismarck, ND, accesses a cloud server to run a simulation, that expense is qualifying. If a remote contractor in Texas accesses the same server for the same project, the portion of the cloud cost attributable to the Texan’s time is generally not considered a North Dakota-sourced in-house research expense.

Primary Sector Businesses and Credit Transferability

One of North Dakota’s most distinct regulatory features is the enhanced benefit for “primary sector businesses.” These are businesses certified by the Department of Commerce as adding value to a product, process, or service that results in the creation of new wealth.

Selling Unused Credits

Unlike many states where R&D credits can only be carried forward, North Dakota allows qualified research and development companies to sell, transfer, or assign up to $100,000 of their unused credits. This is a vital source of non-dilutive capital for small startups that have high in-house research expenses but no current tax liability.

To qualify for credit transfer, the business must:

1. Be a certified primary sector business.
2. Have conducted qualified research in North Dakota for the first time after December 31, 2006.
3. Have annual gross revenues of less than $750,000.

The transferor and transferee must jointly file Form CTS (Credit Transfer Statement) within 30 days of the sale. The purchaser receives the credit at its face value but is prohibited from carrying the credit back to prior years.

Filing and Compliance: Local State Revenue Office Guidance

The North Dakota Office of State Tax Commissioner provides specific filing instructions for each entity type. Failure to attach the required schedules or documentation can result in the immediate disallowance of the credit.

Entity-Specific Filing Requirements

Supporting Documentation and Audit Readiness

The Tax Commissioner does not mandate a specific “state Form 6765” (the federal equivalent), but requires taxpayers to attach a schedule or worksheet detailing the calculation. Under Administrative Code 81-01.1-01-04, the Commissioner has broad authority to request audit information, and taxpayers generally have 30 days to respond to such requests.

Key documentation that must be maintained for at least four years includes:

• Project Lists: Descriptions of the research activities that meet the four-part test.
• W-2 and Payroll Records: Evidence of wages paid and the percentage of time allocated to R&D.
• Invoices for Supplies: Documentation showing the purchase and consumption of materials within North Dakota.
• Cloud Computing Agreements: Contracts and usage logs for computer time used for research.
• Property Tax Clearance: Certification that the business and its responsible officers are in good standing with each county where they own a 50% or greater interest in real property.

Economic Impact and Statistical Overview

The North Dakota research expense tax credit is a high-impact policy tool. Legislative Council memorandums and Department of Commerce reports provide a snapshot of the credit’s performance and its role in the state budget.

Twenty-Year Performance Summary

An evaluation over a 20-year period revealed that while the credit represents a net budgetary liability, its broader economic benefits are substantial.

In the 2016 tax year alone, individuals claimed over $4.5 million in credits, while corporations claimed over $500,000. These statistics suggest that the credit is particularly effective at supporting small-to-medium enterprises and individual entrepreneurs within the state.

Comprehensive Calculation Example: “Northern Bio-Tech LLC”

To illustrate the application of “in-house research expenses,” consider Northern Bio-Tech LLC, a Fargo-based startup developing a new biodegradable plastic. The company is a certified primary sector business.

Scenario: Tax Year 2024

• Employee A (Lead Scientist, Fargo): $150,000 total wages. 90% of time spent on R&D.
• Employee B (Lab Technician, Fargo): $80,000 total wages. 100% of time spent on R&D.
• Employee C (Sales Manager, Grand Forks): $100,000 total wages. 5% of time spent on R&D (direct supervision of lab cleaning).
• Employee D (Remote Engineer, Minneapolis, MN): $120,000 total wages. 100% of time spent on R&D.
• Supplies: $50,000 in raw polymers consumed in prototype creation in the Fargo lab.
• Computer Usage: $20,000 in cloud processing costs for chemical structural modeling, accessed by the Fargo team.
• Base Amount History: The average North Dakota QREs for the three preceding years (2021-2023) was $200,000.

Step 1: Identify Qualified In-House Research Expenses

1. Employee A Wages: Since 90% > 80%, the “substantially all” rule applies. $150,000 is includable.
2. Employee B Wages: 100% of $80,000 is includable.
3. Employee C Wages: 5% of $100,000 is $5,000. Even though it’s a small amount, it is direct supervision conducted in ND.
4. Employee D Wages: $0. The work was performed outside North Dakota.
5. Supplies: $50,000. These were consumed in ND-based research.
6. Computer Usage: $20,000. Directed by the ND team.

Total Current Year ND QREs: $150,000 + $80,000 + $5,000 + $50,000 + $20,000 = $305,000.

Step 2: Calculate the Credit (ASC Method)

Northern Bio-Tech elects the ASC method for 2024.

1. ASC Base Amount: 50% of the 3-year average ($200,000) = $100,000.
2. Alternative Excess: $305,000 – $100,000 = $205,000.
3. Tier 1 Credit: 17.5% of the first $100,000 = $17,500.
4. Tier 2 Credit: 5.6% of the remaining $105,000 = $5,880.

Total North Dakota R&D Credit: $17,500 + $5,880 = $23,380.

Step 3: Strategic Outcome

Northern Bio-Tech has a tax liability of only $3,000. They utilize $3,000 of the credit and have an unused portion of $20,380. They can:

• Carry the $20,380 back three years for an immediate refund.
• Carry the balance forward for up to 15 years.
• Because they are a certified primary sector business with low revenue, they may elect to sell this $20,380 credit to another taxpayer for cash.

Emerging Trends and Future Outlook

The North Dakota tax system is currently navigating several significant changes that will impact the value and administration of R&D credits in the coming years.

The One Big Beautiful Bill (OBBB) Act

The 2025 legislative session introduced the OBBB Act, which fundamentally reshaped the state’s approach to capital investment and R&D expensing. While federal law now requires the amortization of domestic research expenditures over five years under the TCJA changes, the OBBB Act provides for the full expensing of domestic research and experimental (R&E) expenses in the year they occur for North Dakota tax purposes. This “de-coupling” from federal amortization rules makes North Dakota an even more attractive destination for R&D-heavy industries, as it provides an immediate tax deduction in addition to the credit.

Automation and Primary Sector Synergy

There is a growing synergy between the R&D tax credit and the Automation Equipment Purchase Credit. Taxpayers that automate a manufacturing or animal agricultural process in North Dakota can claim a credit of up to 15% of the equipment cost. Many companies find that their in-house research expenses are focused on developing the automated systems that they then purchase and claim under the automation credit, creating a powerful “innovation-to-implementation” tax shield.

Final Thoughts: Strategic Value of In-House Research

In-house research expenses are the fundamental metric by which North Dakota measures and rewards innovation. By aligning its definitions with IRC Section 41, the state provides a familiar framework for businesses, while its strict geographic sourcing ensures that the resulting tax benefits remain rooted in the local economy. For business leaders, the “meaning” of these expenses is found in their versatility: they are not just deductions but can be converted into immediate cash through transferability, carried back to recover prior year taxes, or carried forward to fuel future expansion.

As North Dakota continues to de-couple from restrictive federal amortization rules and strengthens its support for primary sector automation, the strategic importance of accurately tracking and sourcing in-house R&D costs will only grow. Success in this area requires a proactive approach to documentation, an intimate understanding of the physical location of R&D performance, and a comprehensive view of how these credits interact with the broader state economic development landscape. For those who master these nuances, the North Dakota R&D credit offers one of the most potent incentives for technological growth in the United States.