The Mechanics and Implications of the Alternative Simplified Credit in North Dakota’s Research and Development Landscape

The North Dakota Alternative Simplified Credit (ASC) rate of 17.5% represents the statutory percentage applied to the first $100,000 of alternative excess qualified research expenses for taxpayers electing a simplified calculation method. This mechanism allows businesses to incentivize innovation by benchmarking current research spending against 50% of their average qualified research expenses from the preceding three years.

Statutory Framework and the Evolution of the Research Expense Credit

The legal foundation for the North Dakota Research and Experimental Expenditure Tax Credit resides within North Dakota Century Code (N.D.C.C.) § 57-38-30.5. This statute provides a comprehensive income tax credit for taxpayers who conduct qualified research within the geographic boundaries of the state. To understand the specific 17.5% rate associated with the Alternative Simplified Credit (ASC), one must first grasp the broader historical context of how the state has incentivized technological advancement over the last four decades.

The credit was originally enacted in 1987 via House Bill No. 1645. At its inception, the credit was relatively modest, offering an 8% credit on the first $1.5 million of excess research expenses and 4% on any amount exceeding that threshold. For the first twenty years of its existence, the credit primarily served larger corporate entities that could navigate the complexities of “base period” calculations, which required detailed historical records of both research spending and gross receipts.

A major structural shift occurred in 2007 with the passage of House Bill Nos. 1412 and 1018. These pieces of legislation expanded the credit’s availability to individuals and passthrough entities, such as S-corporations and Limited Liability Companies (LLCs), which are common structures for emerging technology and agricultural firms in North Dakota. Furthermore, the 2007 reforms introduced the concept of “transferability,” allowing small, primary-sector businesses to sell their unused credits to other taxpayers—a provision that significantly enhanced liquidity for startups with high research costs but no immediate tax liability.

The modern era of the credit began in 2017 when the legislature standardized the tiered percentage system for the “regular” method. For any research beginning after 2016, the allowable credit was set at 25% of the first $100,000 of excess expenses and 8% for any amounts above that. However, as businesses increasingly aligned their state filings with federal standards, the need for a simplified alternative became apparent. This led to the introduction of the Alternative Simplified Credit (ASC) method in 2019.

Federalization and the Definition of Qualified Research

North Dakota’s tax code is “federalized,” meaning it adopts the definitions provided in the Internal Revenue Code (IRC) by reference. For the research credit, N.D.C.C. § 57-38-30.5 explicitly states that “qualified research expenses” and “base amount” carry the same meaning as defined under IRC § 41. This alignment simplifies compliance for multi-state entities, yet the state imposes a strict geographical limitation: the expenses must be attributable to activities conducted specifically within North Dakota.

To qualify for the credit—under either the regular method or the 17.5% ASC method—an activity must satisfy the federal “Four-Part Test”:

1. Permitted Purpose: The research must be intended to develop or improve a product, process, software, formula, or invention to be held for sale, lease, license, or use in a trade or business.
2. Elimination of Uncertainty: The taxpayer must encounter technical uncertainty regarding the capability, method, or appropriate design of the intended innovation.
3. Process of Experimentation: The taxpayer must engage in a systematic evaluation of alternatives, such as through modeling, simulation, or systematic trial-and-error testing.
4. Technological in Nature: The process must rely on principles of the physical sciences, biological sciences, engineering, or computer science.

Mechanics of the 17.5% Alternative Simplified Credit

The Alternative Simplified Credit (ASC) was introduced to provide an elective pathway for calculating the R&D credit that does not require historical gross receipts data. While the “regular” method relies on a company’s sales history to establish a “base,” the ASC method relies exclusively on the company’s history of research spending.

The Tiered Rate Structure of the ASC

Under the ASC method, the credit is divided into two tiers based on the amount of “alternative excess research and development” generated in the taxable year. The 17.5% rate is the primary incentive for the first $100,000 of incremental spending, while a lower rate applies to larger research footprints.

The term “alternative excess research and development” is defined by the Office of State Tax Commissioner as the amount of qualified research expenses (QREs) for the current year that exceeds 50% of the average QREs for the three preceding taxable years. This “moving base” allows the credit to reward companies that are actively increasing their research investment relative to their own recent past.

Calculating the 3-Year Average Base

The base calculation for the ASC is significantly simpler than the regular method. If a taxpayer is filing for the 2024 tax year, they must determine their North Dakota QREs for 2021, 2022, and 2023. The sum of these three years is divided by three to find the average. The “base” against which the 2024 spending is measured is then exactly half of that average.

This structure provides a distinct advantage to companies that may have high gross receipts but relatively low or consistent R&D spending. Because the regular method’s base is tied to sales, a highly profitable company might find it difficult to exceed its “base amount” even if it spends millions on research. The ASC method removes the sales variable entirely, focusing the incentive on the growth of the research budget itself.

Zero-Expense Years and the 7.5% Contingency

One of the most critical aspects of the ASC guidance from the North Dakota Tax Commissioner involves taxpayers who lack a complete three-year history of research expenses. If a taxpayer had zero qualified research expenses in any one of the three years preceding the year for which the credit is being determined, the calculation shifts away from the “excess” model.

In these instances, the credit is calculated as follows:

• 7.5% of the first $100,000 of total current-year North Dakota QREs.
• 2.4% of any current-year North Dakota QREs exceeding $100,000.

This provision ensures that startups or companies pivoting into R&D can still utilize the simplified method, even if they cannot establish a three-year “momentum” average. While these rates are lower than the standard 17.5% and 5.6% rates, they apply to the entirety of the current year’s QREs rather than just the excess over a base.

Local State Revenue Office Guidance and Compliance

The North Dakota Office of State Tax Commissioner provides specific procedural instructions for claiming the Research Expense Credit, particularly for taxpayers electing the ASC method. These instructions emphasize that while the state allows the ASC election, it is a binding choice for the year it is made.

Election and Filing Procedures

A taxpayer may elect to use the ASC method by simply calculating the credit under that method on their original income tax return. The state does not require that the taxpayer also use the ASC method for their federal R&D tax credit; a company may use the regular method for federal purposes and the ASC method for North Dakota purposes if it results in a more favorable tax position.

However, the Commissioner’s guidance is firm on the timing of this election. A taxpayer cannot file an amended return to switch to the ASC method for any tax year beginning before January 1, 2019. For current filings, the election must be made on a timely filed original return (including extensions). For individual taxpayers, the credit is reported on Schedule ND-1TC, while corporate taxpayers use Form 40, Schedule TC or Schedule CR.

The Prerequisite of Local Tax Clearance

A distinctive requirement of the North Dakota Research Expense Credit—and one that distinguishes it from many other state-level incentives—is the mandatory “Property Tax Clearance”. Guidance from the Tax Commissioner states that a taxpayer must be in “good standing” with each county in North Dakota where the corporation (or any officer or owner with a 50% or more interest) owns real property.

Before the research credit can be successfully claimed on the state return, the taxpayer must obtain a Property Tax Clearance Record from the relevant counties. This certification confirms that all property taxes are paid and that there are no outstanding liens. This administrative bridge between state-level income tax credits and local-level property tax compliance serves as a mechanism to ensure that businesses receiving significant R&D subsidies are contributing to the basic local infrastructure that supports their operations.

Recordkeeping and Documentation Standards

The Tax Commissioner advises that taxpayers maintain detailed records to substantiate their credit claims for at least four years following the filing. Because the ASC method relies on a three-year lookback, the “closed” nature of prior tax years does not necessarily prevent the Commissioner from reviewing the records of those prior years to verify the 50% average base calculation.

Required documentation typically includes:

• Technical project reports describing the “permitted purpose” and the specific technical uncertainties encountered.
• Detailed payroll records that map specific employee hours to qualified research activities (QRAs).
• Invoices and receipts for supplies used in the development of prototypes or during testing phases.
• Evidence of “direct supervision” or “direct support” for employees involved in the research process.

Monetizing the Credit: Transferability for Primary Sector Businesses

A unique feature of the North Dakota R&D landscape is the ability for certain companies to monetize their credits before they ever turn a profit. This is especially relevant to the 17.5% ASC rate, as high-growth startups often have significant research expenses—and thus large credits—but no tax liability to offset.

Qualified Research and Development Company Certification

To sell, transfer, or assign an unused research credit, a company must be certified by the North Dakota Department of Commerce as a “Qualified Research and Development Company”. The eligibility requirements are stringent:

1. Primary Sector Business: The company must be certified as a primary sector business, which the state defines as a business that, through the employment of knowledge or labor, adds value to a product, process, or service that results in the creation of new wealth. This typically covers manufacturing, agriculture, and high-tech processing.
2. New Research: The company must have begun conducting qualified research in North Dakota for the first time after December 31, 2006.
3. Revenue Threshold: The company must have annual gross revenues of less than $750,000.

The Transfer Limit and Process

The total amount of research credit that a company can transfer over its lifetime is limited to $100,000. When a company elects to transfer a credit, it must find a purchaser who has a North Dakota income tax liability. The transferor and the purchaser must jointly file Form CTS (Credit Transfer Statement) with the Office of State Tax Commissioner within 30 days of the execution of the transfer agreement.

The purchaser takes the credit with the same rights as the original earner, with one major exception: the purchaser cannot carry the credit back to prior tax years. The purchaser may, however, carry the credit forward for up to 15 years. This system creates a localized market for innovation, where established North Dakota corporations can support early-stage startups by purchasing their tax benefits at a negotiated rate.

Quantitative Application: A Detailed Calculation Example

To clarify how the 17.5% ASC rate interacts with the tiered system and the three-year average base, consider a hypothetical North Dakota technology firm, “Fargo Aerospace Systems.”

Background Data

Fargo Aerospace has elected to use the ASC method for the 2024 tax year. They have the following history of North Dakota Qualified Research Expenses (QREs):

• 2021 QREs: $250,000
• 2022 QREs: $300,000
• 2023 QREs: $350,000
• 2024 (Current Year) QREs: $500,000

Step 1: Calculate the 3-Year Average

The first step is to find the arithmetic mean of the previous three years of research spending:

Average QRE = ($250,000 + $300,000 + $350,000) / 3 = $300,000

Step 2: Establish the ASC Base Amount

The base amount for the Alternative Simplified Credit is defined as 50% of this average:

ASC Base = $300,000 × 0.50 = $150,000

Step 3: Determine the Alternative Excess

The “alternative excess” is the current year’s spending minus the ASC base:

Alternative Excess = $500,000 – $150,000 = $350,000

Step 4: Apply the Tiered Credit Rates

The calculation now applies the 17.5% rate to the first $100,000 of that excess and the 5.6% rate to the remainder:

1. Tier 1 (17.5%): The first $100,000 of alternative excess is multiplied by 0.175.
   $100,000 × 0.175 = $17,500
2. Tier 2 (5.6%): The remaining excess ($350,000 – $100,000 = $250,000) is multiplied by 0.056.
   $250,000 × 0.056 = $14,000

Total North Dakota R&D Credit for 2024:

Total Credit = $17,500 + $14,000 = $31,500

Comparison with the “Regular” Method

If Fargo Aerospace had used the regular method, their credit would depend on their gross receipts. If their “regular” base amount was $400,000 (calculated via the fixed-base percentage method), their regular excess would only be $100,000 ($500k – $400k).

• Regular Method Credit: $100,000 × 0.25 = $25,000.

In this case, despite the 17.5% ASC rate being lower than the 25% regular rate, the ASC method produces a larger credit ($31,500 vs. $25,000) because the base amount is significantly lower. This illustrates why the ASC method is a powerful tool for companies whose research budgets are growing faster than their historical revenue-based benchmarks.

Comparative Analysis: North Dakota in the Regional R&D Market

North Dakota’s use of a tiered system for its ASC method is a relatively aggressive approach compared to other states in the Upper Midwest and beyond. While many states offer a flat rate for their simplified credit, North Dakota’s front-loaded 17.5% rate is designed to maximize the impact for small-to-midsize research projects.

North Dakota’s 17.5% rate is notably high for the initial $100,000 of excess, providing a strong incentive for companies to relocate or expand their research operations into the state. While a state like Arizona offers a 24% credit, it does not utilize the simplified 50% base method, meaning the barrier to entry (the “base amount”) may be much higher for many companies.

Carryback and Carryforward Provisions

The flexibility of the North Dakota credit is further enhanced by its carryback and carryforward rules, which are among the most generous in the United States. Guidance from the Office of State Tax Commissioner confirms that if a credit exceeds the taxpayer’s liability for the year it was earned, the unused portion must follow a specific sequence:

1. 3-Year Carryback: The unused credit must first be carried back to the three preceding taxable years, starting with the earliest year. A claim for a carryback must be filed within three years of the due date of the return for the year the credit was earned.
2. 15-Year Carryforward: If any credit remains after the three-year carryback, it may be carried forward for up to 15 succeeding taxable years.

This 18-year “window” of utility ensures that research investments made during lean years can be used to offset taxes during future periods of high profitability. For companies using the 17.5% ASC rate, this long-term flexibility is crucial for managing the multi-year cycle of product development common in the aerospace, energy, and pharmaceutical sectors.

Statistics and Economic Impact: Legislative Oversight

The North Dakota Legislative Council conducts regular reviews of economic development tax incentives, including the Research and Experimental Expenditure Tax Credit. These studies aim to determine if the incentives are serving their intended purposes in a cost-effective manner.

The 6-Year Review Cycle

Under N.D.C.C. § 54-35-26, the interim Taxation Committee is required to review each major economic development incentive at least once every six years. In 2019, North Dakota was identified by Pew Charitable Trusts as a national leader in evaluating the economic impact of tax incentives. The evaluation process looks at:

• Positive influence on business behavior (i.e., would the research have occurred without the credit?).
• Effect on the state economy and job creation in the primary sector.
• Complementary or duplicative effects of other governmental programs.

Usage Patterns and Fiscal Impact

Legislative reports indicate that the Research Expense Credit is a significant component of North Dakota’s corporate tax expenditure budget. For the 2023-2025 biennium, the state continues to monitor how the addition of the ASC method has expanded the claimant base. While the “regular” method remains popular for established firms, the 17.5% ASC rate has seen growing adoption among “middle-market” firms that find the three-year average base easier to manage than the long-term gross receipts tracking required by the older method.

Industry-Specific Implications: Agriculture, Energy, and Beyond

The application of the 17.5% ASC rate varies significantly across the core industries of North Dakota’s economy. The “primary sector” requirement for credit transferability specifically targets these industries to align with state goals of economic diversification and value-added production.

Agricultural Innovation

In the Red River Valley and across the state’s agricultural hubs, research is focused on crop science, precision agriculture, and autonomous machinery. For a family-owned seed development company, the ASC method is often preferred because agricultural revenue can be highly volatile due to commodity price fluctuations. By using the ASC’s 17.5% rate, these companies can establish a base tied to their own steady R&D spending rather than their erratic annual sales.

Energy and Carbon Capture

North Dakota’s energy sector, particularly in the Bakken formation, is a hotbed for R&D in enhanced oil recovery and carbon sequestration. For these firms, the 17.5% ASC rate often applies to the “alternative excess” created by large-scale pilot projects. The state’s guidance allows for the inclusion of wages for engineers and technicians onsite, as well as the cost of materials consumed during testing phases.

Manufacturing and Value-Added Processing

Manufacturers in the state often combine the R&D credit with the Automation Tax Credit (which provides a 15% credit for purchasing automated equipment). While a company cannot claim both the R&D credit and the Automation Credit on the exact same dollar of equipment cost, they often use the R&D credit for the development of the automation software and the Automation Credit for the purchase of the physical robotic hardware. This “stacking” of incentives, including the 17.5% ASC rate for the initial R&D phase, makes North Dakota a highly competitive location for advanced manufacturing.

Administrative Hurdles: Avoiding Common Pitfalls

Taxpayers claiming the 17.5% ASC rate must be wary of several common errors that can lead to the disallowance of the credit during a state audit.

Miscalculating the Base Period

The most common error in ASC filings involves the “average” of the prior three years. Taxpayers must ensure they are using “North Dakota QREs”—not total federal QREs—for all three years of the lookback period. If a company includes expenses from a Minnesota branch in its base years, it will artificially inflate the base and reduce the current year’s excess, resulting in a smaller (and potentially incorrect) credit.

Failure to Document the “Nexus” of Research

Auditors from the Office of State Tax Commissioner look for a clear nexus between the expense and the state. If a North Dakota company hires a remote software developer living in Texas, the wages paid to that developer generally do not qualify for the North Dakota R&D credit, even if they qualify for the federal credit. Proper payroll documentation must show that the work was physically performed within North Dakota’s borders.

Ignoring the Property Tax Clearance Requirement

As previously discussed, the credit is contingent on property tax standing. Many corporations discover too late that a minor, unpaid property tax bill in a rural county—perhaps on a small parcel of land or an officer’s interest—can hold up the processing of a multi-million dollar R&D tax credit. Proactive confirmation of property tax status in all active counties is a mandatory step in the R&D tax planning process in North Dakota.

Final Thoughts: The Strategic Value of the 17.5% Rate

The North Dakota Alternative Simplified Credit and its signature 17.5% rate represent a sophisticated effort by the state to modernize its innovation incentives. By providing a tiered system that rewards the first $100,000 of incremental research spending at a high percentage, the state has lowered the barrier to entry for small-to-midsize firms while maintaining a sustainable support system for large-scale industrial players.

The guidance provided by the Office of State Tax Commissioner reinforces the importance of meticulous recordkeeping and the unique prerequisite of local tax clearance. For primary sector businesses, the combination of a simplified calculation method, 18 years of carryback/carryforward flexibility, and the ability to monetize credits through transferability makes the North Dakota R&D credit a cornerstone of the state’s economic development strategy.

As North Dakota continues its 6-year review cycles and legislative adjustments, the 17.5% ASC rate remains a critical benchmark for the state’s technological future. Businesses that understand the nuances of the “alternative excess” calculation and the administrative requirements of Schedule RD are well-positioned to leverage this incentive to fuel their next generation of products, processes, and breakthroughs.