IRC Section 174

IRC Section 174 dictates the federal tax accounting treatment of research and experimental expenditures, mandating a shift from immediate expensing to multi-year amortization that directly impacts a business’s taxable income. In North Dakota, this federal provision is inextricably linked to the state’s research expense tax credit through a rolling conformity mechanism, where federal timing changes for deductions determine the net fiscal value of state-level innovation incentives.

The interaction between federal tax law and state-specific incentives represents one of the most complex areas of corporate tax planning for North Dakota entities. Internal Revenue Code (IRC) Section 174 serves as the primary gateway for defining what constitutes a research expense, while North Dakota Century Code (N.D.C.C.) § 57-38-30.5 provides the mechanism for a direct reduction in state tax liability. Since North Dakota adopts the federal definition of taxable income as its starting point, any modification to the timing or deductibility of research costs at the federal level causes an immediate and proportional shift in North Dakota’s tax base. This relationship became particularly strained following the Tax Cuts and Jobs Act (TCJA) of 2017, which eliminated the long-standing ability to expense research costs immediately, replacing it with a five-year (domestic) or fifteen-year (foreign) amortization requirement for tax years beginning after December 31, 2021. However, the enactment of the One Big Beautiful Bill Act (OBBBA) on July 4, 2025, has restored immediate expensing for domestic research activities starting in 2025, while introducing intricate transition rules for the unamortized costs trapped in the 2022–2024 period. Understanding these shifts is paramount for North Dakota businesses, as they navigate the tiered credit rates, transferability options for startups, and the procedural requirements of the North Dakota Office of State Tax Commissioner.

The Federal Architecture of IRC Section 174

The historical development of IRC Section 174 reflects a deliberate federal policy intended to encourage technological advancement by reducing the tax friction associated with innovation. Originally enacted in 1954, Section 174 was designed to eliminate the uncertainty of whether research and development (R&D) costs should be treated as ordinary business expenses or as capital investments that created an intangible asset with an indefinite life. For nearly seventy years, the default treatment allowed taxpayers to deduct these expenditures in the year they were paid or incurred, providing immediate liquidity that businesses could reinvest into further experimental activities.

The Tax Cuts and Jobs Act (TCJA) fundamentally altered this landscape. To offset the cost of lowering the headline corporate tax rate, the federal government moved to capitalize and amortize “specified research or experimental” (SRE) expenditures. This policy change, which took effect in 2022, required domestic research costs to be amortized over five years and foreign research costs to be amortized over fifteen years, using a mid-year convention. The impact of this shift was a significant increase in taxable income for research-intensive firms, as they could only deduct 10% of their domestic R&D costs in the first year of the expenditure.

Defining Specified Research or Experimental Expenditures (SREs)

The definition of what constitutes an SRE under Section 174 is broader than the definition of “Qualified Research Expenses” (QREs) used for the Section 41 Research Credit. While Section 41 focuses on the direct “boots on the ground” research activities, Section 174 encompasses all costs incident to the research and experimentation process in the experimental or laboratory sense.

According to Treasury Regulation 1.174-2 and updated guidance in IRS Notice 2023-63, SRE expenditures include:

• Direct Labor: Salaries, wages, and benefits for employees directly performing or supervising research, as well as those in direct support of such activities.
• Materials and Supplies: Costs for items consumed during the laboratory process or in the creation of pilot models and prototypes.
• Contract Research: 100% of the costs paid to third parties for research performed on the taxpayer’s behalf, whereas Section 41 typically only allows 65%.
• Overhead and Occupancy: A portion of rent, utilities, insurance, and maintenance costs for facilities and equipment used in research.
• Depreciation and Depletion: The depreciation of assets used in research (e.g., a lab spectrometer) is itself treated as a Section 174 expenditure.
• Software Development: The TCJA explicitly stated that any amount paid or incurred in connection with the development of software is an SRE expenditure.

Category	Section 174 (SREs)	Section 41 (QREs)
Direct Wages	100% Eligible	Eligible (W-2 Box 1)
Materials	100% Eligible	100% Eligible
Contract Research	100% Eligible	65% – 75% Eligible
Utilities/Rent	Proportionally Eligible	Ineligible
Foreign Research	15-Year Amortization	Ineligible
Software Dev	100% Eligible	Subject to 4-Part Test

North Dakota’s Statutory Framework for R&D Incentives

North Dakota’s commitment to fostering a high-tech economy is codified in N.D.C.C. § 57-38-30.5, which provides a research expense tax credit. The state has historically structured this credit to be one of the most competitive in the nation, particularly for primary sector businesses such as those in manufacturing, agriculture, and energy.

Legislative Evolution of N.D.C.C. § 57-38-30.5

The North Dakota research credit has undergone several major iterations since its inception in 1987. Originally modeled after Minnesota’s tax laws, the credit was initially restricted to corporate income taxpayers and provided a relatively modest 8% credit for the first $1.5 million of excess research expenses.

A transformative shift occurred during the 2007 legislative session with the passage of House Bill Nos. 1412 and 1018. These bills expanded the credit’s availability to individuals, estates, trusts, and pass-through entities (PTEs) such as S-corporations and LLCs. Furthermore, the 2007 amendments introduced the tiered credit structure that remains in place today, rewarding the first $100,000 of excess spending at a much higher rate to encourage participation among small businesses and startups.

In 2013, the state legislature added a crucial safeguard in Senate Bill No. 2207. This provision ensures that even if the federal government were to discontinue the federal research tax credit (Section 41), the North Dakota state credit would remain effective by maintaining its own statutory references to the federal definitions as they existed at a specific point in time. More recently, in 2019, the state adopted the Alternative Simplified Computation (ASC) method, providing taxpayers with a streamlined way to calculate the credit that aligns with federal reporting.

The Core Definitions and Geofencing

While the North Dakota credit relies on federal definitions, it is strictly “geofenced.” For the purposes of N.D.C.C. § 57-38-30.5:

• Qualified Research: Shares the definition in IRC § 41(d), but specifically excludes any research conducted outside the state of North Dakota.
• Qualified Research Expenses (QREs): Shares the definition in IRC § 41(b), but excludes expenses incurred for basic research conducted outside North Dakota.
• Base Amount: Shares the definition in IRC § 41(c), but excludes sales or research activities conducted outside the state.

This geographic restriction means that a North Dakota company with R&D teams in both Fargo and Minneapolis must carefully bifurcate its costs. Only the Fargo-based wages, supplies, and contract research are eligible for the North Dakota credit.

The Rolling Conformity Mechanism and the OBBBA

The most critical factor in the current tax landscape is North Dakota’s status as a “rolling conformity” state. Unlike “static conformity” states that tie their tax codes to the IRC as of a specific date (e.g., January 1, 2024), North Dakota automatically adopts federal tax changes as they are signed into law.

Automatic Adoption of Section 174 Changes

When the TCJA’s amortization requirement went into effect in 2022, North Dakota’s corporate and individual tax bases automatically expanded. This created a “phantom income” scenario where businesses had the same cash flow but significantly higher taxable income because 90% of their domestic R&D costs could no longer be deducted in the year incurred.

The enactment of the One Big Beautiful Bill Act (OBBBA) on July 4, 2025, reversed this trend. By creating a new IRC Section 174A, the OBBBA permanently restores the ability to fully expense domestic research and experimental expenditures for tax years beginning after December 31, 2024. Because North Dakota is a rolling conformity state, this restoration of expensing automatically reduces North Dakota taxable income starting in the 2025 tax year, without the need for additional state legislative action.

The Impact of Non-Conformity in Other States

The strategic advantage of North Dakota’s rolling conformity is highlighted when compared to non-conforming or static states. For example, states like California or Wisconsin decoupled from the Section 174 amortization rules, allowing their taxpayers to continue expensing R&D for state purposes even while they amortized for federal purposes. While this was beneficial to taxpayers in 2022, it created massive “book-tax differences” that required separate sets of depreciation and amortization schedules for state and federal returns. North Dakota’s approach maintains simplicity; the federal deduction always matches the state deduction, reducing the administrative burden on small business owners.

Calculating the North Dakota Research Expense Credit

The North Dakota credit is designed to be incremental, meaning it rewards businesses for spending more on R&D than they have in the past. Taxpayers can choose between two primary calculation methods: the Regular Method and the Alternative Simplified Computation (ASC) Method.

The Regular Method

The Regular Method is the “standard” calculation that has been in place since the credit’s inception. It compares current-year QREs to a “base amount.” The base amount is generally calculated as:

Base Amount = Fixed-Base Percentage × Average Annual ND Gross Receipts (Prior 4 Years)

There is a statutory “floor” for the base amount; it can never be less than 50% of the current year’s QREs. For companies that have established North Dakota gross receipts, the credit is tiered as follows:

• 25% for the first $100,000 of excess QREs.
• 8% for any excess QREs exceeding $100,000.

For startups (defined as companies with fewer than five years of receipts), the fixed-base percentage begins at 3% and gradually increases to 16% over a ten-year period.

The Alternative Simplified Computation (ASC) Method

For tax years beginning after 2018, North Dakota allows taxpayers to elect the ASC method. This is often more beneficial for large, established companies with high historical gross receipts that would result in a very high base amount under the regular method.

• Base Amount: 50% of the average North Dakota QREs for the three preceding tax years.
• Excess QREs: Current QREs minus the Base Amount.
• Credit Rate: 17.5% of the first $100,000 of excess QREs plus 5.6% of any excess over $100,000.

If the taxpayer had zero QREs in any of the three preceding tax years, the credit is calculated as 7.5% of the first $100,000 of current QREs plus 2.4% of the remainder.

Method	Application	Tier 1 Rate (First $100k)	Tier 2 Rate (Remainder)
Regular	High R&D Growth	25.0%	8.0%
ASC	Established Spend	17.5%	5.6%
ASC (Zero Spend History)	Startups	7.5%	2.4%

Revenue Office Guidance and Compliance Procedures

The North Dakota Office of State Tax Commissioner (OSTC) provides specific administrative guidance to ensure that credits are claimed accurately and only for legitimate in-state activities.

The Property Tax Clearance Record

A unique requirement for North Dakota tax incentives, including the research credit, is the Property Tax Clearance. Under N.D.C.C. § 57-01-15.1, any taxpayer who owns a 50% or greater interest in real property in any North Dakota county must obtain a clearance record from that county. This record certifies that all property taxes due have been paid. A credit claim will be disallowed if this clearance is not attached to the state income tax return.

Filing Requirements and Schedule ND-1TC

Taxpayers must report the credit on Schedule ND-1TC (for individuals) or the appropriate corporate income tax form. The OSTC requires a detailed worksheet or schedule showing the computation of the credit, the base amount, and the breakdown of QREs by category (wages, supplies, contract research).

If a taxpayer is a pass-through entity (PTE), the credit must be determined at the entity level. The PTE then provides each owner with a North Dakota Schedule K-1, showing their proportional share of the credit based on their ownership percentage.

Carryback and Carryforward Rules

For credits earned from research beginning after December 31, 2006, North Dakota provides generous carryover provisions:

• Carryback: Unused credits must first be carried back to each of the three preceding taxable years.
• Carryforward: Any remaining unused portion can be carried forward for up to fifteen years.

This 15-year window is particularly valuable given the “lumpy” nature of R&D spending and the fact that startups often have no tax liability in their early years.

Transferability: A Strategic Liquidity Tool for Startups

Perhaps the most significant aspect of the North Dakota Research Expense Credit for small businesses is its transferability. Unlike most states, which only allow credits to be used by the entity that generated them, North Dakota allows certain companies to sell their unused credits for cash.

Qualification as a Research and Development Company

To sell a credit, a taxpayer must be certified by the North Dakota Department of Commerce as a “Qualified Research and Development Company.” The eligibility criteria are stringent:

1. Primary Sector Business: The company must be a primary sector business (manufacturing, processing, etc.) that adds value and creates new wealth in North Dakota.
2. Revenue Threshold: The company must have annual gross revenues of less than $750,000.
3. New Research: The company must have conducted qualified research in North Dakota for the first time after December 31, 2006 (or 2016 for certain entities).

The Mechanics of the Transfer

Qualified companies can sell up to $100,000 of unused credits to any other North Dakota taxpayer. This allows a pre-revenue startup to essentially “sell” its tax benefit to a profitable North Dakota corporation.

• Form CTS: Both the transferor (seller) and transferee (buyer) must jointly file Form CTS (Credit Transfer Statement) within 30 days of the transfer agreement.
• Discounted Sales: It is common for credits to be sold at a slight discount (e.g., 85 cents on the dollar), providing the buyer with a profit and the seller with immediate, non-dilutive capital.

Transitional Provisions under the OBBBA and Rev. Proc. 2025-28

The restoration of expensing in 2025 via the OBBBA has left many businesses with “trapped” unamortized basis from the 2022, 2023, and 2024 tax years. Revenue Procedure 2025-28 provides two pathways for these businesses, both of which flow through to North Dakota.

Scenario 1: Small Business Retroactivity (SBR) Election

Eligible small businesses—those with average annual gross receipts of $31 million or less—may elect to retroactively apply the new expensing rules to the 2022–2024 period.

• Mechanism: The taxpayer must amend their federal and North Dakota returns for 2022 and 2023, and potentially 2024 if already filed.
• Result: This converts the amortized deductions into immediate expensing, potentially generating large refunds of taxes paid in those years.
• The 280C Revocation: The OBBBA helpfully allows these taxpayers to revoke or make late elections regarding Section 280C, which coordinates the deduction with the research credit.

Scenario 2: Accelerated Deductions for Other Taxpayers

Companies that are not “small businesses” or those that choose not to amend prior years can instead use the acceleration provision.

• Mechanism: Taxpayers can deduct the entire remaining unamortized amount of their 2022–2024 domestic R&D costs in their first tax year starting after 2024 (the 2025 tax year) or split it across 2025 and 2026.
• Accounting Method Change: This is treated as a change in accounting method. For 2025, the IRS has simplified this process by allowing a simple statement to be attached to the return instead of the full Form 3115.

In North Dakota, this acceleration will likely result in a dramatic reduction in 2025 state tax liability, as companies “flush through” multiple years of deferred R&D deductions simultaneously.

Detailed Example: Case Study of Roughrider Robotics, LLC

To illustrate the interplay of these complex rules, consider Roughrider Robotics, LLC, a fictional Fargo-based company that develops automated harvesting equipment.

Year 1: The Amortization Burden (2023)

In 2023, Roughrider Robotics incurred $400,000 in domestic research wages for its North Dakota engineers.

• Section 174 Treatment: Roughrider was required to capitalize the $400,000 and amortize it over 5 years. Using the mid-point convention, they only deducted $40,000 (10%) on their 2023 North Dakota return.
• ND Credit Calculation: Using the ASC method, and assuming an average prior 3-year spend of $100,000:
• Base = 50% of $100,000 = $50,000.
• Excess QREs = $400,000 – $50,000 = $350,000.
• Tier 1 Credit (17.5% of first $100k) = $17,500.
• Tier 2 Credit (5.6% of next $250k) = $14,000.
• Total ND Credit: $31,500.
• Fiscal Impact: Roughrider paid North Dakota taxes on $360,000 of “phantom income” (the $400,000 spent minus the $40,000 allowed deduction), though this was offset by the $31,500 credit.

Year 3: The OBBBA Restoration (2025)

In 2025, Roughrider Robotics spends another $400,000 on R&D. They also have $320,000 in unamortized basis left over from their 2023 and 2024 spend.

• 2025 Expensing: Under Section 174A, Roughrider immediately deducts the full $400,000 incurred in 2025.
• Acceleration: Roughrider elects to deduct the remaining $320,000 of unamortized prior costs in 2025.
• Total 2025 R&D Deduction: $720,000.
• ND Credit: They still claim a new state credit for the $400,000 spent in 2025, even though they were able to deduct the full amount.
• Net Result: The combination of full current-year expensing and the catch-up deduction likely wipes out Roughrider’s 2025 North Dakota income tax liability entirely, and potentially creates a net operating loss (NOL) they can use in future years.

North Dakota Economic Landscape and R&D Statistics

The health of the North Dakota Research Expense Credit is a reflection of the state’s broader economic engine. While mining (oil and gas) remains the dominant contributor to North Dakota’s GDP, the manufacturing and social services sectors are increasingly vital.

GDP Contribution by Sector (2024 Estimates)

Sector	Contribution to ND GDP	Role in R&D
Mining (Oil/Gas)	High (Relative to Nation)	Process Improvement / CCS
Finance	High	Internal-Use Software
Social Services (Health)	High	Biotech / Medical Research
Manufacturing	Significant	Automation / Product Dev
Government	High	Grant-Funded R&D

This sectoral diversity is reflected in the statistics for the research credit. Historically, a small number of large corporate claimants (roughly 12–19 per year) have claimed between $3 million and $6.5 million in total annual credits. However, the number of individual and pass-through claimants is much higher, often exceeding 150 per year, demonstrating the importance of the credit to the state’s smaller entrepreneurial firms.

Labor and Income Trends

North Dakota’s per capita income in 2024 was $70,966, ranking 18th in the nation and well above the Plains regional average. This high income level, combined with a low poverty rate (10.6%), provides a stable environment for high-wage R&D jobs. The state’s tax environment, with a top corporate rate of 4.31% and a top individual rate of 2.5%, further enhances the value of the R&D credit, as it effectively subsidizes a significant portion of the cost of hiring high-skill engineers and developers in the state.

Final Thoughts: Strategic Imperatives for North Dakota Businesses

The evolution of IRC Section 174 from a static deduction into a dynamic tool of federal fiscal policy has significant implications for North Dakota’s innovation ecosystem. Through the state’s rolling conformity mechanism, North Dakota has maintained a close link to federal standards, ensuring administrative simplicity while automatically providing taxpayers with the benefits of the 2025 OBBBA restoration of R&D expensing.

For North Dakota businesses, the strategic path forward involves three primary actions:

1. Immediate Evaluation of Retroactivity: Small businesses should consult with their tax advisors to model the value of amending 2022 and 2023 returns. The SBR election provides a time-sensitive opportunity to recover cash through retroactive expensing, but this must be balanced against the administrative cost of filing amended state and federal returns.
2. Rigorous Documentation of In-State Activities: To secure the tiered 25% and 8% North Dakota credit rates, firms must be prepared to prove that their research was conducted physically within North Dakota borders. This is especially critical for remote-work environments where developers may be located in other jurisdictions.
3. Utilization of Transferability for Liquidity: Early-stage primary sector companies should actively seek certification from the North Dakota Department of Commerce. The ability to sell up to $100,000 in credits annually represents a critical source of non-dilutive capital that can be used to bridge the gap from prototype to commercialization.

As North Dakota continues to diversify its economy and integrate advanced automation and digital solutions into its traditional agriculture and energy bases, the Research Expense Credit will remain the state’s most powerful tool for attracting and retaining the intellectual capital necessary for long-term growth.