Individual Income Tax

Individual income tax in North Dakota is a personal levy on the earnings of residents and certain non-residents, serving as the terminal point for tax credits generated by passthrough entities. This fiscal mechanism allows individual taxpayers to utilize the Research and Experimental Expenditure Credit to offset personal tax liabilities dollar-for-dollar based on innovation-related spending within the state.

The conceptual foundation of North Dakota’s tax policy is built upon the synergy between the state’s revenue needs and its strategic objective to foster a high-tech, knowledge-based economy. For the individual taxpayer, the personal income tax is not merely a financial obligation but a platform for participating in the state’s economic growth through targeted incentives. The Research and Experimental Expenditure Credit, colloquially referred to as the R&D credit, represents one of the most significant of these incentives. By allowing the benefits of corporate-level innovation to flow through to individual owners, partners, and shareholders, the state ensures that the entrepreneurial spirit of small and mid-sized businesses is directly rewarded. This detailed analysis explores the statutory framework, the specific guidance provided by the Office of State Tax Commissioner, and the practical application of the credit within the context of the North Dakota individual income tax system.

The Statutory Framework of Individual Income Tax in North Dakota

The legal authority for the imposition of individual income tax and the granting of research-related credits is found in Title 57 of the North Dakota Century Code (N.D.C.C.). The state tax system is fundamentally “coupled” with the federal Internal Revenue Code, meaning that North Dakota generally adopts federal definitions of income and many business-related expenses as the starting point for state tax calculations. However, the state maintains its own specific provisions for credits that are designed to meet local economic objectives, most notably the income tax credit for research and experimental expenditures found in N.D.C.C. § 57-38-30.5.

North Dakota individual income tax is calculated using a simplified method that begins with federal taxable income. For residents, the tax applies to all income regardless of its source, while for non-residents, the tax is apportioned based on the amount of income derived from North Dakota sources. The tax rates are historically competitive, reflecting the state’s broader fiscal strategy of maintaining a lean government funded primarily by a mix of sales, use, and energy-related taxes, with individual income tax serving as a secondary but vital component.

Tax Component	Legal Reference	Function
Simplified Individual Tax	N.D.C.C. § 57-38-30.3	Establishes the method for computing personal income tax based on federal taxable income.
Research Expense Credit	N.D.C.C. § 57-38-30.5	Defines eligibility, calculation methods, and carryover rules for the R&D incentive.
Property Tax Clearance	N.D.C.C. § 57-01-15.1	Mandates that taxpayers must be current on property taxes to claim state incentives.
Primary Sector Definition	N.D.C.C. § 1-01-49	Defines the types of businesses eligible for specialized certification and credit transfers.

The interaction between the individual income tax and the R&D credit is most prevalent in the world of passthrough entities. Because entities such as S corporations, partnerships, and limited liability companies (LLCs) do not typically pay income tax at the entity level, their tax attributes—including income, deductions, and credits—pass through to the individual owners. These owners then report their share of the business’s research activities on their personal North Dakota tax returns.

The Research and Experimental Expenditure Tax Credit: Core Definitions

The North Dakota Research and Experimental Expenditure Tax Credit is an incentive for taxpayers who incur qualified research expenses (QREs) while conducting technical activities within the state. To understand how this credit applies to the individual income tax, one must first master the definitions of “qualified research” and “base amount,” both of which are rooted in federal law but modified by state-specific geographic constraints.

The Federal Nexus and the Four-Part Test

North Dakota largely adopts the definition of “qualified research” as established in Section 41(d) of the Internal Revenue Code (I.R.C.). For an activity to generate the credit, it must satisfy a rigorous Four-Part Test. This test ensures that the incentive is directed toward true technical innovation rather than routine business improvements or aesthetic design.

The first component of the test is the “Permitted Purpose.” The research must be intended to develop a new or improved “business component,” which is defined as a product, process, computer software, technique, formula, or invention to be held for sale, lease, or use in the taxpayer’s trade or business. The improvement must focus on the function, performance, reliability, or quality of the component.

The second component is the “Elimination of Uncertainty.” A taxpayer must demonstrate that they encountered technical uncertainty at the outset of the project. This means the information available at the time did not establish the capability of developing the component, the method for doing so, or the appropriate final design.

The third component is the “Process of Experimentation.” The taxpayer must engage in a systematic evaluation of alternatives to overcome the identified uncertainty. This typically involves modeling, simulation, systematic trial and error, or the testing of various design iterations. The guidance from the state revenue office emphasizes that this must be a “technical” process, not merely a marketing or social science exercise.

The final component is that the research must be “Technological in Nature.” The process of experimentation must fundamentally rely on the principles of physical or biological science, engineering, or computer science. This requirement distinguishes R&D from research in the humanities, economics, or business management.

Geographic Limitations and North Dakota Sourcing

While the technical definition of research is federal, the geographic scope is strictly limited to the state of North Dakota. For an individual to claim the credit against their state income tax, all associated research activities must be performed within the state’s borders. This geographic restriction applies to both the current-year expenditures and the historical “base amount” used in the calculation.

Qualified Research Expenses (QREs) in North Dakota include several categories of spending. “Wages” consist of the salaries and wages paid to employees for time spent performing research or providing direct supervision or support for research activities within the state. “Supplies” include tangible property used in the conduct of research, excluding land or improvements to land. “Contract Research” is allowed at 65% of the amount paid to third parties for qualified research performed on the taxpayer’s behalf, provided that work is done in North Dakota. Additionally, “Cloud Computing” costs for the use of computers for research purposes are eligible if the research activity itself has a North Dakota nexus.

Expense Category	Eligibility Requirement	Standard Percentage for Credit
In-House Wages	Research must be performed in North Dakota.	100% of qualified portion.
Supplies	Property must be consumed in ND research.	100% of qualified portion.
Contract Research	Work must be performed by contractor in ND.	65% of amount paid.
Computer Leasing	Equipment/Cloud must support ND research.	100% of qualified portion.

Calculation Methodologies: The Regular and ASC Methods

The North Dakota Office of State Tax Commissioner provides two primary methods for calculating the credit: the Regular Method and the Alternative Simplified Computation (ASC) method. The selection of a method is an annual election made by the taxpayer, and it is binding for the taxable year in which it is made.

The Regular Method and Tiered Percentages

The Regular Method is the traditional approach and is based on the excess of current-year QREs over a “base amount.” The base amount is generally a fixed-base percentage of the taxpayer’s average gross receipts for the preceding four tax years, though it cannot be less than 50% of the current-year QREs. The regular method uses a tiered percentage structure that is particularly favorable for smaller-scale innovators.

Under current law, for taxpayers who began research after 2006, the credit is equal to 25% of the first $100,000 of qualified research expenses in excess of the base amount, and 8% of all excess expenses over $100,000. This structure provides a high-impact incentive for the initial layers of research investment, which often represent the most difficult phase of development for small businesses and individual entrepreneurs.

Historical context is important for the Regular Method. For taxpayers who first earned or claimed the credit before January 1, 2007, the percentages for the amount over $100,000 were phased in over several years, reaching the current 8% after a period of fluctuation. These “legacy” taxpayers are also subject to an annual credit cap of $2 million, and any amount earned in excess of this cap cannot be carried back or forward.

The Alternative Simplified Method (ASC)

Recognizing that the Regular Method’s reliance on historical gross receipts and fixed-base percentages can be administratively burdensome, the North Dakota legislature introduced the ASC method for tax years beginning after December 31, 2018. The ASC method mirrors the simplified method found in federal law but is independently elected at the state level. A taxpayer may choose to use the ASC method for their North Dakota return even if they used the Regular Method for their federal return.

The ASC method defines “North Dakota alternative excess research and development expenses” as the amount by which current-year QREs exceed 50% of the average QREs for the three tax years preceding the tax year for which the credit is being determined.

The ASC calculation uses the following tiers:

1. 17.5% of the first $100,000 of alternative excess expenses.
2. 5.6% of any alternative excess expenses over $100,000.

If a taxpayer had zero qualified research expenses in any of the three preceding tax years, a different rate applies: 7.5% of the first $100,000 of current QREs plus 2.4% of the remainder. This “zero-year” provision ensures that startups or newly innovating firms can still access the credit through the simplified method without being penalized for a lack of history.

Calculation Method	Base Requirement	Primary Rate (First $100k)	Secondary Rate (Over $100k)
Regular Method	ND Base Amount (I.R.C. § 41(c))	25%	8%
ASC Method	50% of 3-Year Avg ND QREs	17.5%	5.6%
ASC (No History)	Zero Base	7.5%	2.4%

Application to Individual Income Tax and Passthrough Entities

The most complex aspect of the Research Expense Credit is its application to individual income tax through the mechanism of passthrough entities. For many individuals, the credit is not earned by them personally (as in a sole proprietorship) but is instead allocated to them as a partner in a partnership or a shareholder in an S corporation.

The Flow-Through Mechanism

When a passthrough entity incurs QREs in North Dakota, the entity calculates the total credit using either the Regular or ASC method. This total credit is then divided among the owners based on their respective ownership interests in the entity. Each owner is provided with a Schedule K-1, which reports their share of the credit.

The individual taxpayer then reports this credit on Schedule ND-1TC, which is the form used to claim various income tax credits on the individual income tax return (Form ND-1). Line 9a of Schedule ND-1TC is designated for the research expense tax credit. The individual must attach documentation to their return, which typically includes the Schedule K-1 from the passthrough entity and a worksheet or schedule detailing how the credit was calculated at the entity level.

An important limitation applies to individual owners: the credit allowed for the taxable year may not exceed the amount of North Dakota income tax attributable to the individual’s interest in the trade, business, or entity that generated the credit. This “limitation of credit to tax” ensures that a taxpayer cannot use an R&D credit from a specific business to wipe out tax liability generated by unrelated income, such as wages from a different job or investment income from a different source.

Carryback and Carryforward Provisions for Individuals

Innovation rarely aligns perfectly with a single tax year’s profitability. To address this, North Dakota provides robust carryback and carryforward rules for the research credit. If the amount of the credit exceeds the individual’s tax liability for the current year, the unused portion is not lost.

The unused credit must first be carried back to the three preceding taxable years, starting with the earliest year first. This allows the taxpayer to recover taxes paid in prior years through an amended return. If the credit is not fully utilized in the carryback years, it may then be carried forward for up to fifteen taxable years. A claim to carry back the credit must be filed within three years of the due date (including extensions) of the return for the year in which the credit was earned.

Unused Credit Rule	Duration	Requirement
Carryback	3 Years	Must go to earliest year first; file within 3 years of return due date.
Carryforward	15 Years	Applies to any remainder after carryback; offsets future liability.
Exception	No Carry	Credits earned in excess of the $2M pre-2007 cap cannot be carried.

Guidance for Small Businesses: Transferability and Sale of Credits

A distinctive feature of North Dakota’s incentive structure is the ability for certain small businesses to sell, transfer, or assign their unused R&D credits. This provision is specifically tailored to “qualified research and development companies” that are in the early stages of growth and may have significant research expenditures but no current tax liability.

Certification as a Qualified R&D Company

To be eligible to transfer a credit, the taxpayer (which, for this purpose, is limited to an individual, C corporation, estate, or trust) must be certified by the North Dakota Department of Commerce Division of Economic Development and Finance. The business must meet all of the following conditions:

1. It must be a “primary sector business” as defined by state law.
2. It must have conducted qualified research in North Dakota for the first time after December 31, 2006.
3. It must have annual gross revenues of less than $750,000.
4. It must not have previously earned or claimed the North Dakota research credit.

This certification process requires the submission of form SFN 58638 along with a description of the new research and copies of relevant federal tax information.

The Mechanics of the Transfer

Once certified, a taxpayer may sell or transfer up to a lifetime total of $100,000 of unused credit to another taxpayer. This creates a valuable “cash equivalent” for startups, as they can sell the credit to an established taxpayer (often at a discount) to obtain immediate capital for their operations.

The transferor and the purchaser must jointly file Form CTS (Credit Transfer Statement) within 30 days of the transfer. The purchaser of the credit then claims it on their own North Dakota tax return. However, several restrictions apply to the purchaser: they cannot carry the purchased credit back to prior years, and they cannot resell the credit to another party. For individual purchasers, these “purchased” credits are reported on Line 9b of Schedule ND-1TC.

Local Revenue Office Guidance and Compliance Requirements

The North Dakota Office of State Tax Commissioner provides detailed administrative guidance to ensure that taxpayers claim the credit accurately and remain in compliance with state law. This guidance covers everything from the initial filing of the return to the documentation required in the event of an audit.

Property Tax Clearance: The Gatekeeper Requirement

One of the most critical and unique administrative hurdles in North Dakota is the Property Tax Clearance requirement. Under N.D.C.C. § 57-01-15.1, a taxpayer must be in good standing with regard to their property taxes before they can claim certain state tax incentives, including the research credit.

Specifically, the taxpayer must obtain a property tax clearance record from each North Dakota county in which they hold a 50% or more ownership interest in real property. This record(s) must be attached to the North Dakota tax return (Form ND-1) on which the credit is claimed. This requirement highlights the state’s policy of ensuring that those who benefit from state-level tax reductions are also contributing their share to local government services through property taxes.

Documentation and Recordkeeping Standards

The state revenue office emphasizes that the burden of proof for the credit lies entirely with the taxpayer. This is especially true for individual taxpayers who receive a credit through a passthrough entity, as they may not have direct access to the underlying project records. The revenue office recommends that taxpayers maintain contemporaneous evidence of their research activities and expenditures.

Recommended documentation includes:

• Project Documentation: Records describing the research goals, the technical uncertainties encountered, and the systematic process of experimentation used to address those uncertainties.
• Personnel Records: Payroll data and time-tracking records that identify which employees performed research and the exact percentage of their time dedicated to qualified activities in North Dakota.
• Expense Substantiation: Invoices, receipts, and general ledger details for supplies and contract research. Contracts for third-party research must clearly specify that the work is to be performed in North Dakota.
• Business Transfers: If a taxpayer acquires or disposes of a portion of a business, they must adjust their QREs and base amount in accordance with the rules of I.R.C. § 41(f)(3).

The North Dakota Tax Commissioner has the authority to audit these claims and disallow the credit if the documentation is found to be insufficient or if the activities do not meet the definition of qualified research. Records should be retained for at least four years, aligning with the state’s standard audit window.

Comprehensive Example: Calculating and Applying the Credit

To illustrate the practical application of these rules, consider the case of “AgriTech Innovations LLC,” a North Dakota-based partnership owned equally by two individuals, Mark and Lisa.

The Business Scenario

In the 2024 tax year, AgriTech Innovations conducts research into automated soil nutrient sensors in Grand Forks. The firm identifies the following expenses:

• Wages for research engineers in ND: $200,000
• Supplies used in testing: $40,000
• Payments to a ND software consultant: $100,000 (of which $65,000 is qualified)
• Total ND QREs for 2024: $305,000

The firm’s average QREs for the prior three years (2021-2023) were $200,000. The firm elects to use the Alternative Simplified Method (ASC) for its 2024 state return.

Step 1: Calculate the Credit at the Entity Level

Using the ASC method, the base is 50% of the three-year average:

Base = 0.50 × 200,000 = 100,000

The “alternative excess” research expenses are:

Excess = 305,000 – 100,000 = 205,000

The credit tiers are applied as follows:

• 17.5% of the first $100,000: $17,500
• 5.6% of the remaining $105,000: $5,880
• Total Entity Credit: $23,380

Step 2: Allocation to the Individual Owners

As 50% partners, Mark and Lisa are each allocated $11,690 of the credit. This amount is reported to them on their respective North Dakota Schedule K-1s from the partnership.

Step 3: Application to Individual Income Tax

Mark’s North Dakota income tax liability (Form ND-1) before credits is $15,000. He reports his interest in the partnership and the $11,690 credit on Schedule ND-1TC, Line 9a.

Mark’s final tax calculation:

15,000 (Liability) – 11,690 (R&D Credit) = 3,310 (Net Tax Due)

Mark must also ensure that the $11,690 credit does not exceed the portion of his $15,000 tax liability that is specifically attributable to his income from AgriTech Innovations LLC. He must also attach his Property Tax Clearance record and his Schedule K-1 to his return.

Comparative Analysis: The R&D Credit vs. Other Individual Incentives

The Research Expense Credit exists within a broader ecosystem of tax incentives available to individual North Dakotans. Understanding how it compares to other credits provides insight into the state’s economic priorities and helps taxpayers optimize their overall tax strategy.

Incentive Program	Individual Eligibility	Key Rate/Limit	Comparison with R&D Credit
Automation Credit	Passthrough Owners	15% of equipment cost; $3M state cap.	Focuses on capital equipment; R&D focuses on intellectual activity.
Internship Credit	Passthrough Owners	10% of salary; $3,000 max per intern.	Targeted at workforce development; R&D is broader.
Seed Capital Credit	Individual Investors	45% of investment; $3.5M state cap.	High-rate credit for passive investors in primary sector firms.
Angel Fund Credit	Individual Investors	Varies (often 25-45%).	Incentivizes equity investment in high-growth startups.
Workforce Recruitment	Passthrough Owners	5% of compensation for 12 months.	Supports hiring for hard-to-fill positions.

The R&D credit is unique in that it is “uncapped” for most modern businesses, whereas many other credits, such as the Automation or Seed Capital credits, are subject to a statewide “first-come, first-served” limit that can result in proration if the total amount claimed by all taxpayers exceeds a certain threshold (e.g., $3 million or $3.5 million annually). This makes the R&D credit a more predictable component of a long-term business plan.

Statistical and Economic Impact Analysis

Data from the North Dakota Tax Commissioner’s 57th Biennial Report and various Department of Commerce annual reports suggest that the research credit is a vital, albeit concentrated, component of the state’s fiscal landscape. While sales and excise taxes generate the bulk of state revenue ($6.3 billion in recent cycles), individual and corporate income taxes provide the structural flexibility to offer these targeted incentives.

For the period between 2017 and 2021, the Department of Commerce reported that over 800 business incentive agreements were entered, with a total value exceeding $172 million. These incentives, which include the R&D credit through primary sector certifications, were instrumental in the creation and retention of over 3,400 jobs, far exceeding legislative goals.

Fiscal Metric	Value (Approx.)	Source
Total General Fund Revenue (FY 2023)	$6.3 Billion	6
Total Business Incentives (2017-2021)	$172.6 Million	20
R&D Transfer Limit (Lifetime)	$100,000	11
Pre-2007 Legacy Annual Credit Cap	$2 Million	1
State Appropriation for Property Relief	$503.3 Million	22

The usage of the R&D credit has been particularly meaningful in the agriculture and energy sectors, where small firms are constantly developing new techniques for soil management, seed optimization, and energy extraction. By allowing these benefits to flow to individuals, North Dakota ensures that the wealth generated by these innovations stays within the state’s communities.

Future Outlook: Federal Conformity and Legislative Trends

The future of the North Dakota R&D credit is heavily influenced by changes at the federal level. Because the state uses federal taxable income as its base, federal legislation like the “One Big Beautiful Bill Act” (OBBBA) of 2025 automatically impacts the calculation of state taxes. For example, if the federal government adjusts the standard deduction or the treatment of business expenses, North Dakota’s individual tax revenue will fluctuate accordingly.

One major point of contention in recent years has been the federal requirement under I.R.C. Section 174 to capitalize and amortize R&D expenses over five years rather than expensing them immediately. This change, which took effect for tax years beginning after 2021, creates a timing mismatch where businesses (and their individual owners) must pay tax on “phantom” income today, recovering the deduction only slowly over several years. North Dakota’s choice to maintain a high-percentage R&D credit (25% on the first $100,000) acts as a crucial offset to these federal pressures, providing the immediate cash-flow relief that the new capitalization rules have constrained.

Furthermore, the state legislature continues to explore ways to simplify the tax code while maintaining robust support for primary sector businesses. The success of the ASC method introduced in 2019 suggests that further simplification or the introduction of “refundable” components for startups may be a topic of future debate, similar to programs seen in other states like Arkansas or Maine.

Final Thoughts

The Research and Experimental Expenditure Tax Credit is more than just a line item on a tax return; it is a fundamental pillar of North Dakota’s strategy to bridge its traditional strengths in agriculture and energy with a high-tech future. For the individual taxpayer, the meaning of income tax in this context is transformed from a passive obligation to an active opportunity for investment and growth.

The synergy between the North Dakota Office of State Tax Commissioner and the Department of Commerce creates a multi-layered support system. While the revenue office provides the guidance for calculations and compliance, the Department of Commerce ensures that the incentive is targeted toward businesses that generate new wealth and job opportunities in the state. For individual owners of passthrough entities, the 25% tiered rate and the 15-year carryforward period provide a level of financial flexibility that is among the best in the nation.

However, the benefits of the credit come with significant responsibilities. Adherence to the Four-Part Test, the maintenance of strict North Dakota nexus documentation, and the completion of the Property Tax Clearance mandate are non-negotiable requirements for those seeking to reduce their tax liability. By maintaining these high standards of compliance, North Dakota protects the integrity of its incentive programs while ensuring that its tax system remains a competitive advantage for all who call the state home. As the economic landscape continues to evolve, the intersection of individual income tax and research-driven innovation will remain the primary engine of prosperity for the state’s entrepreneurial community.