Base Amount (for R&D Credit)

The North Dakota base amount represents the statutory threshold of historical research spending a business must exceed to qualify for the state’s incremental research and development tax credit. It effectively filters out baseline operational costs, ensuring that tax incentives are only granted for new, expanded research investments conducted strictly within the state’s borders.

This foundational concept of the base amount is the engine that drives North Dakota’s Research and Experimental Expenditure Tax Credit, primarily governed by North Dakota Century Code (N.D.C.C.) § 57-38-30.5. To appreciate the base amount’s role, one must view it as a benchmark of historical effort. The state tax policy is designed not merely to reward the existence of research and development (R&D), but to incentivize the growth of that research over time. By tying the credit to expenditures “in excess of” a defined base, the legislature ensures that state revenue is utilized to foster innovation that would not have occurred under a business-as-usual scenario. This methodology mirrors the federal approach under Internal Revenue Code (IRC) § 41, yet it introduces a rigorous geographic filter that requires a nuanced understanding of state-specific revenue office guidance and statutory requirements.

The Statutory Evolution of North Dakota’s Innovation Incentives

The history of the Research and Experimental Expenditure Tax Credit in North Dakota is marked by a deliberate shift from a narrow corporate incentive to a broad-based economic tool. Understanding this history is essential for taxpayers because the year in which a company first began its research activities in the state dictates which credit rates and base amount limitations apply to their current filings.

Origins and the 1987 Framework

The credit was first introduced in 1987 through House Bill No. 1645. At its inception, the law was modeled after successful legislation in Minnesota, reflecting a regional trend toward using tax policy to attract high-tech industry. Initially, the credit was quite restricted, applying only to corporations. The original statutory language provided for a credit of 8 percent on the first $1.5 million of qualified research expenses that exceeded a base period amount, and 4 percent for any amount beyond that threshold. These early provisions established the “incremental” nature of the credit, a principle that remains today.

The 2007 Transformation

A massive restructuring occurred during the 2007 legislative session with the passage of House Bill Nos. 1018 and 1412. These bills fundamentally changed the credit’s accessibility and utility. First, eligibility was expanded beyond C-corporations to include individuals and passthrough entities like S-corporations and partnerships. This change was significant for North Dakota’s economy, which features a high density of small-to-mid-sized businesses and agricultural processors structured as passthrough entities.

Second, the 2007 legislation introduced the concept of transferable credits. This allowed “qualified research and development companies”—typically small, primary-sector startups—to sell or assign their unused credits to other taxpayers. This mechanism addressed the common problem where innovative startups have significant R&D costs and potential credits but no tax liability to offset. By allowing the sale of these credits, the state provided a vital source of non-dilutive capital to burgeoning tech firms.

Modern Refinements: 2011 to 2021

Since 2007, the legislature has continued to refine the base amount definitions and credit rates to ensure fiscal responsibility while maintaining an attractive business climate. In 2011, the credit rate for expenses exceeding the first $100,000 of excess QREs was set at 8 percent for new claimants.

The 2019 session introduced the Alternative Simplified Method (ASC), providing an optional, streamlined way to calculate the base amount that mirrors the federal ASC. This was a response to taxpayer feedback that the historical “Regular Method” was becoming increasingly difficult to calculate for companies that did not have records dating back to the 1980s or whose revenue had grown so significantly that the traditional base amount became an insurmountable hurdle. Most recently, in 2021, the state temporarily increased tax liability limits, allowing the credit to offset a larger portion of a taxpayer’s total bill, further signaling the state’s support for high-growth sectors.

Legislative Milestone	Primary Change	Impact on Base Amount/Credit
1987 (HB 1645)	Initial Enactment	Corporate only; 8%/4% rates; 3-year carryback.
2007 (HB 1018/1412)	Expansion & Transferability	Included passthrough entities; allowed $100k transfer for small biz.
2011 Amendment	Rate Standardization	8% rate set for expenses over $100k for new claimants.
2019 (SB 2223)	ASC Implementation	Introduced Alternative Simplified Method; 50% of 3-year average QREs.
2021 Amendment	Liability Cap Increase	Increased tax offset limit from 25% to 50% for specific years.

Detailed Analysis of the Regular Incremental Method

The Regular Method is the traditional way to determine the North Dakota base amount. It is inherently tied to a company’s research intensity relative to its gross receipts. Under this method, the base amount is not a static number but a moving target that adjusts as a business grows.

The Fixed-Base Percentage

The first component of the Regular Method is the fixed-base percentage. This figure is meant to represent the taxpayer’s historical commitment to R&D. For established companies—those that were active during the 1984–1988 period—the fixed-base percentage is the ratio of their total qualified research expenses to their total gross receipts for that specific window.

However, for “start-up” firms—which North Dakota defines as companies that did not have both gross receipts and qualified research expenses in at least three years during the 1984–1988 period—the law provides a statutory phase-in for the fixed-base percentage. This prevents new companies from being penalized with an unfairly high base amount early in their lifecycle.

Year of Research Activity	Fixed-Base Percentage (Start-ups)
1st through 5th years	3%
6th year	1/6 of actual % of QREs to Gross Receipts
7th year	1/3 of actual % of QREs to Gross Receipts
8th year	1/2 of actual % of QREs to Gross Receipts
9th year	2/3 of actual % of QREs to Gross Receipts
10th year	5/6 of actual % of QREs to Gross Receipts
11th year and beyond	Actual % of QREs to Gross Receipts (up to 16%)

The maximum fixed-base percentage is capped at 16 percent to ensure that even high-intensity research firms can eventually benefit from the credit as they scale.

Average Annual Gross Receipts

The second component is the average annual gross receipts for the four taxable years preceding the credit year. Importantly, in the North Dakota context, “gross receipts” must be restricted to those “attributable to North Dakota”. This means a multi-state corporation must filter its total sales to include only those occurring within the state’s borders. Revenue office guidance specifies that returns and allowances should be excluded from this calculation.

The 50 Percent Floor Rule

A critical safeguard in the Regular Method is the “50 percent rule.” According to N.D.C.C. § 57-38-30.5 and mirroring IRC § 41(c)(2), the base amount cannot be less than 50 percent of the qualified research expenses for the taxable year for which the credit is being determined.

The implication of this rule is profound: it limits the credit for companies that may have had very low historical spending or very high current spending. It ensures that at least half of the current year’s research is considered “base” activity that does not qualify for the incentive. For rapidly expanding companies, this 50 percent floor often becomes the actual base amount used in their final calculation.

The Alternative Simplified Method (ASC) Mechanics

The Alternative Simplified Method, available for tax years beginning after December 31, 2018, offers a less burdensome calculation for many taxpayers. Unlike the Regular Method, which looks back to the 1980s or requires a 4-year average of gross receipts, the ASC focuses solely on a 3-year history of research expenditures.

Calculating the ASC Base Amount

Under the ASC, the base amount is defined as 50 percent of the average qualified research expenses incurred in North Dakota for the three tax years preceding the tax year for which the credit is being determined.

The formula for the ASC Base Amount is:

Base Amount (ASC) = 0.50 × [(QRE(year-1) + QRE(year-2) + QRE(year-3)) / 3]

This method is particularly advantageous for companies that have high or volatile gross receipts, as the ASC base amount is entirely decoupled from revenue. It rewards companies that are consistently increasing their R&D spend year-over-year.

The Zero-Spending Provision

The North Dakota Office of State Tax Commissioner provides specific guidance for taxpayers who do not have a three-year history of research. If a taxpayer had zero qualified research expenses in any of the three preceding years, the credit is calculated differently. In these cases, the credit is equal to 7.5 percent of the first $100,000 of current year QREs, plus 2.4 percent of the expenses exceeding $100,000. This “no-history” rate is lower than the standard ASC rates but allows new researchers to claim a benefit immediately without waiting three years to establish a baseline.

Annual Election and Binding Nature

Taxpayers may choose on a year-to-year basis whether to use the Regular Method or the ASC. However, once an election is made on a filed return for a specific tax year, it is binding for that year. Businesses often perform “side-by-side” calculations to determine which method yields a higher credit before filing.

Defining “Qualified Research” and Geographic Nexus

The integrity of the base amount depends entirely on the correct identification of Qualified Research Expenses (QREs). North Dakota adopts the federal definition found in IRC § 41(d), but imposes a strict geographic mandate: the research must be “done within the state of North Dakota”.

The Four-Part Test in North Dakota

To qualify for the credit—and to be included in the historical base—an activity must satisfy four criteria:

1. Permissible Purpose: The research must relate to a new or improved function, performance, reliability, or quality of a business component.
2. Technological in Nature: The activity must fundamentally rely on the principles of physical or biological science, engineering, or computer science.
3. Elimination of Uncertainty: The research must be intended to discover information that would eliminate uncertainty concerning the development or design of a product or process.
4. Process of Experimentation: The taxpayer must engage in a process designed to evaluate alternatives, such as modeling, simulation, or systematic trial and error.

The North Dakota Filter

Revenue office guidance is explicit: even if an activity meets the federal four-part test, it is disqualified if it occurs outside North Dakota. This includes:

• Wages: Only the portion of a North Dakota employee’s wages directly related to R&D performed within the state can be included.
• Supplies: Only supplies used in the conduct of qualified research in North Dakota are eligible.
• Contract Research: If a company hires a third party to conduct research, that research must be performed within North Dakota. Generally, 65 percent of contract research costs are includable as QREs, provided the geographic nexus is met.

Comprehensive Examples of Calculation

To bridge the gap between theory and practice, the following examples demonstrate how the base amount functions under different business scenarios.

Example 1: Established Corporation (Regular Method)

“Bismarck Bio-Tech” has been conducting research in North Dakota since 1985.

• Current Year (2024) ND QREs: $500,000.
• Fixed-Base Percentage: 4% (Calculated from 1984-1988 data).
• Average ND Gross Receipts (2020-2023): $8,000,000.

Step 1: Calculate the Tentative Base Amount.

$8,000,000 × 0.04 = $320,000

Step 2: Apply the 50% Floor Rule.

50% of current QREs ($500,000) = $250,000

Since $320,000 is greater than $250,000, the final Base Amount is $320,000.

Step 3: Calculate Excess QREs.

$500,000 – $320,000 = $180,000

Step 4: Apply Tiered Credit Rates.

• 25% of the first $100,000: $25,000.
• 8% of the remaining $80,000: $6,400.
• Total Credit: $31,400.

Example 2: High-Growth Startup (Alternative Simplified Method)

“Fargo Robotics” is a newer company with rapidly growing sales.

• Current Year (2024) ND QREs: $1,000,000.
• Average ND QREs (2021-2023): $600,000.

Step 1: Calculate the ASC Base Amount.

50% of $600,000 = $300,000

Step 2: Calculate Alternative Excess.

$1,000,000 – $300,000 = $700,000

Step 3: Apply ASC Tiered Rates.

• 17.5% of the first $100,000: $17,500.
• 5.6% of the remaining $600,000: $33,600.
• Total Credit: $51,100.

In this scenario, if Fargo Robotics had used the Regular Method and their average revenue was $30 million with a 4% fixed-base, their base amount would have been $1.2 million, resulting in zero credit. This illustrates why the ASC is a vital tool for high-revenue growth companies.

Revenue Office Guidance on Filing and Compliance

The North Dakota Office of State Tax Commissioner provides a structured framework for claiming the credit. While there is no standalone “Form 6765” as there is at the federal level, the state requires detailed reporting integrated with the annual income tax return.

Corporate Filing Requirements (Form 40)

For C-corporations, the credit is managed through Form 40. Taxpayers must complete Schedule TC (Tax Credits).

• Line 6 of Schedule TC: Report research and experimental expenditure credits generated by the taxpayer in the current year.
• Line 7 of Schedule TC: Report research and experimental expenditure credits purchased from another taxpayer.
• Worksheets: Corporations must attach a worksheet detailing the calculation of the base amount, the current year QREs, and the application of the tiered rates.

Individual and Passthrough Filing (Schedule ND-1TC)

Individuals, including partners and shareholders of passthrough entities, claim the credit on their Form ND-1 by attaching Schedule ND-1TC.

• Pro-Rata Share: If the credit is generated by a partnership or S-corporation, the entity calculates the credit at the entity level and allocates it to owners based on their interest.
• Supporting Documentation: Individual taxpayers must attach a copy of the Schedule K-1 received from the passthrough entity, which should specify the amount of R&D credit being passed through.

Fiduciary Filing (Form 38)

Trusts and estates use Form 38 and report credits on Schedule 38-TC. The guidance for fiduciaries mirrors the corporate and individual rules, emphasizing that any credit exceeding the current liability must be carried back three years and then forward for fifteen.

Form / Schedule	Taxpayer Type	Role in R&D Credit
Form 40, Sch TC	C-Corporation	Primary reporting of generated and purchased credits.
Form ND-1, Sch ND-1TC	Individuals	Claims share of credit from passthrough or personal activity.
Form 38, Sch 38-TC	Estates & Trusts	Reporting and carryover management for fiduciaries.
Form 58 / Form 60	Partnerships / S-Corps	Calculate credit at entity level; distribute via Sch K-1.
Form CTS	All Transferees	Statement required to document a credit purchase.

The “Primary Sector” and Transferability Provisions

North Dakota offers a unique benefit to small businesses that meet the definition of a “primary sector business.” These companies can effectively monetize their research credits even if they are not yet profitable.

Defining a Primary Sector Business

A primary sector business is one that through the employment of knowledge or labor, adds value to a product, process, or service that results in the creation of new wealth in the state. This typically includes:

• Manufacturing and assembly.
• Agricultural processing.
• Energy development.
• Software development and telecommunications.

Certification as a Qualified R&D Company

To sell or transfer credits, a business must be certified by the North Dakota Department of Commerce Economic Development & Finance Division. The criteria for certification via SFN 58638 include:

1. The business must be a certified Primary Sector Business.
2. Annual gross revenues must be less than $750,000.
3. The business must be conducting “new” research in North Dakota.
4. The business must not have previously claimed the North Dakota R&D tax credit.

Transfer Mechanics and Limits

A qualified company may sell up to $100,000 of unused credits over its lifetime. This is not an annual limit but a cumulative one. The transferor (seller) and transferee (buyer) must file Form CTS (Credit Transfer Statement) within 30 days after the date the purchase agreement is executed.

Purchased credits are subject to specific rules:

• The buyer can use the credit to reduce their tax liability, regardless of the seller’s actual liability.
• Unlike generated credits, purchased credits cannot be carried back to prior years by the buyer; they can only be used in the year of purchase and carried forward.
• The seller must report the gross proceeds from the sale of the credit on their state tax return as income (e.g., Line 14 of Form 40).

Statistics and Economic Impact of the Credit

North Dakota’s investment in R&D tax incentives is periodically reviewed by the Legislative Council and the Office of State Tax Commissioner. The data reflects a program that, while carrying a fiscal cost, serves as a cornerstone of the state’s professional and technical services sector.

Claimant Trends and Fiscal Impact

During the 2007–2016 period, approximately 1,800 taxpayers claimed the Research and Experimental Expenditure Tax Credit.

• In the 2016 tax year alone, individuals (mostly through passthrough entities) claimed over $4.5 million in credits.
• Corporate claims for the same year were significantly lower, at just over $500,000, highlighting the importance of the 2007 expansion to passthrough entities.

Employment and GDP Outcomes

The economic ripple effects of the credit are substantial. At its peak, the incentive was credited with:

• Adding approximately 1,100 high-paying jobs to the state.
• Increasing the state’s population by roughly 1,000 individuals.
• Impacting the state’s GDP by approximately $80 million annually.

From a fiscal perspective, a 20-year projection showed that the state generated $213 million in direct revenue from companies utilizing the credit, while the direct cost of the credits was $66 million. However, when accounting for indirect costs such as population maintenance and public services, the state recorded a net liability of roughly $30 million compared to a scenario where no credit was offered. This suggests that the credit is a long-term strategic investment in industrial diversification rather than a short-term revenue generator.

Administrative Compliance and Audit Risk

Navigating the base amount calculation requires rigorous record-keeping. The North Dakota Office of State Tax Commissioner maintains the right to audit and adjust claims, and the consequences for non-compliance can be significant.

Record Retention Guidance

Taxpayers are advised to retain all project documentation for at least four years. This should include:

• Project Lists: Detailed descriptions of research projects and how they meet the Four-Part Test.
• Employee Logs: Records of time spent by employees on qualified activities.
• Financial Statements: General ledgers and invoices for supplies and contract research.
• Gross Receipts Verification: Documentation supporting the “North Dakota only” filter applied to the base amount calculation.

The Property Tax Clearance Requirement

A unique administrative hurdle in North Dakota is the Property Tax Clearance Record. To claim the R&D credit, a taxpayer (and its responsible officers) must be in good standing with each county where they own a 50 percent or more interest in real property. This certification must be included with the tax return. Failure to be current on property taxes in even one county can lead to the immediate denial of the research credit.

Penalties and Interest

Compliance with filing deadlines is essential. For fiduciary returns (Form 38), if the tax is not paid by the due date, a penalty equal to 5 percent of the unpaid tax or $5.00 (whichever is greater) is applied. If the return is not filed by the due date and there is unpaid tax, the penalty increases by 5 percent each month, up to a maximum of 25 percent. Interest is also charged on unpaid taxes at a rate of 1 percent per month.

Final Thoughts: Strategic Takeaways for North Dakota Businesses

The North Dakota base amount is the defining boundary between routine operations and incentivized innovation. For the modern business operating in the Peace Garden State, the choice of base amount methodology—Regular versus Alternative Simplified—is a critical tax planning decision that can swing the value of the credit by tens of thousands of dollars.

As North Dakota continues to transition its economy toward advanced manufacturing, energy innovation, and high-tech agriculture, the Research and Experimental Expenditure Tax Credit remains a vital tool for growth. For established firms, the Regular Method rewards long-term research intensity, while the ASC provides a flexible pathway for high-growth startups to establish a baseline and begin capturing benefits almost immediately. By understanding the “federalized” definitions, adhering to the “North Dakota only” geographic filters, and maintaining rigorous compliance with Department of Revenue and Department of Commerce certification requirements, businesses can effectively utilize these incentives to drive the next generation of technological breakthroughs within the state.