Alternative Simplified Computation (ASC)

The North Dakota Alternative Simplified Computation is an optional methodology for calculating the state’s research expense tax credit, utilizing a three-year rolling average of spending to determine the incentive. It allows taxpayers to claim a percentage of qualified research expenses that exceed fifty percent of their average expenditure from the preceding three years, providing a streamlined alternative to the more complex regular incremental method.

Theoretical and Legislative Origins of the Alternative Simplified Computation

The introduction of the Alternative Simplified Computation (ASC) into the North Dakota Century Code represents a significant modernization of the state’s fiscal policy regarding innovation incentives. Codified under N.D.C.C. § 57-38-30.5, the ASC was designed to lower the administrative barriers that often prevent eligible businesses from claiming the Research and Experimental Expenditure Tax Credit. For decades, the North Dakota credit relied on the regular incremental method, which requires a historical analysis of gross receipts and research spending dating back several decades or to the inception of the business. This traditional approach, while effective for established corporations with robust historical records, proved cumbersome for emerging technology firms and companies undergoing rapid structural changes.

The legislative intent behind adopting the ASC in 2019 was to align North Dakota’s tax structure with federal standards while maintaining the state’s competitive edge in attracting primary sector businesses. By mirroring the federal ASC method found in Internal Revenue Code (I.R.C.) § 41, North Dakota simplified the compliance process for taxpayers already performing these calculations for their federal returns. However, the state law remains distinct in its requirement that all qualified research expenses (QREs) be sourced specifically within North Dakota. This “North Dakota-only” restriction ensures that the tax benefit correlates directly with economic activity, payroll, and investment within the state’s borders.

The evolution of the credit highlights a shift in North Dakota’s economic philosophy. Initially established in 1987 to stimulate corporate R&D, the credit was significantly restructured in 2007 to include individuals and passthrough entities, such as S-corporations and Limited Liability Companies (LLCs). The 2019 addition of the ASC method serves as the latest major milestone in this evolution, reflecting a broader national trend toward “simplified” credits that prioritize recent spending over long-term historical baselines.

Statutory Definitions and Federal Alignment

The operational validity of an ASC claim in North Dakota depends on a precise understanding of what constitutes “qualified research” and “qualified research expenses.” The state legislature opted for a “federalized” approach, meaning that North Dakota generally adopts the definitions found in the Internal Revenue Code, specifically Section 41.

Qualified Research Criteria

To qualify for the North Dakota credit, whether using the regular method or the ASC, an activity must satisfy the federal “Four-Part Test”. This ensures that the state is not subsidizing routine business activities but is instead incentivizing genuine technological advancement.

Scope of Qualified Research Expenses (QREs)

Under N.D.C.C. § 57-38-30.5, only expenses incurred for research conducted within the state are eligible. This exclusion of out-of-state activity is absolute; even if a project is managed from a North Dakota headquarters, any wages paid for work performed outside the state or supplies consumed in out-of-state facilities must be backed out of the calculation.

Eligible expenses are categorized into four primary groups:

• Wages: Includes salaries and wages paid to employees directly involved in research, as well as those providing direct supervision or direct support.
• Supplies: Costs for tangible property, excluding land and depreciable assets, that are used in the conduct of research.
• Contract Research: Taxpayers may claim 65% of the amounts paid to third parties for research conducted on their behalf in North Dakota.
• Basic Research Payments: Specific payments made to qualified organizations, such as North Dakota universities, for basic research.

Comparative Analysis of Calculation Methodologies

North Dakota allows taxpayers to choose between the Regular Incremental Method and the ASC on an annual basis. This flexibility is a powerful tool for tax planning, as the “best” method often shifts depending on a company’s revenue growth and R&D spending trajectory.

The Regular Incremental Method

The regular method calculates the credit based on the excess of current-year QREs over a “base amount”. The base amount is determined by multiplying a “fixed-base percentage” by the taxpayer’s average annual gross receipts for the four years preceding the tax year.

Base_Regular = Fixed-Base % × Average Gross Receipts_ND

A critical limitation in the regular method is that the base amount can never be less than 50% of the current year’s QREs. The credit rates for the regular method are tiered:

• 25% of the first $100,000 of excess expenses.
• 8% of the excess expenses over $100,000.

The Alternative Simplified Computation (ASC) Method

The ASC method, available for tax years after 2018, replaces the complex gross receipts calculation with a simpler three-year spending average. The “alternative excess research and development expenses” is the amount by which current North Dakota QREs exceed 50% of the average North Dakota QREs from the three preceding tax years.

Base_ASC = 50% × (QRE_t-1 + QRE_t-2 + QRE_t-3) / 3

The credit rates for the ASC are also tiered, though the percentages are lower than the regular method to account for the generally lower base amount:

• 17.5% of the first $100,000 of ASC excess.
• 5.6% of the ASC excess over $100,000.

Strategic Considerations: When to Elect the ASC

The decision to elect the ASC method is typically driven by the interplay between a company’s revenue and its research intensity. Because the regular method’s base amount is tied to gross receipts, companies with rapidly growing revenues may find their “base amount” increasing so quickly that it erodes their eligible “excess” expenses. In contrast, the ASC method is indifferent to revenue, focusing solely on research spending.

The “Zero-Year” Rule for New Entrants

The North Dakota legislature included a specific provision for taxpayers who lack qualified research expenses in one or more of the three preceding years. This often applies to startups or established firms moving into new technological fields. Under this “Zero-Year” exception, the three-year average calculation is bypassed.

Instead, the credit is calculated as:

• 7.5% of the first $100,000 of current-year QREs.
• 2.4% of current-year QREs in excess of $100,000.

This provision ensures that companies are not penalized for a lack of history, providing an immediate, albeit lower-rate, incentive for initiating R&D activity in the state.

Mathematical Example of Method Comparison

Consider a manufacturing firm, “Dakota Precision,” with the following financial profile:

• Current Year (2024) QREs: $500,000
• 2021-2023 Average QREs: $400,000
• Regular Method Base Amount (calculated from receipts): $350,000

Calculation A: Regular Method

1. Calculate Excess: $500,000 – $350,000 = $150,000.
2. Tier 1 Credit: $100,000 × 25% = $25,000.
3. Tier 2 Credit: $50,000 × 8% = $4,000.
4. Total Credit: $29,000.

Calculation B: ASC Method

1. Calculate ASC Base: $400,000 × 50% = $200,000.
2. Calculate ASC Excess: $500,000 – $200,000 = $300,000.
3. Tier 1 Credit: $100,000 × 17.5% = $17,500.
4. Tier 2 Credit: $200,000 × 5.6% = $11,200.
5. Total Credit: $28,700.

In this scenario, the regular method provides a slightly higher benefit. However, if Dakota Precision’s gross receipts had spiked in 2023, raising their regular base amount to $400,000, the ASC would likely become the superior choice.

Local State Revenue Office Guidance and Compliance

The North Dakota Office of State Tax Commissioner provides extensive guidance on the administration of the research expense credit, emphasizing the importance of proper certification and documentation. Unlike many other state credits, North Dakota’s R&D incentive involves both the Tax Department and the Department of Commerce, particularly when transferability or primary sector certifications are involved.

Certification as a Qualified Research and Development Company

For businesses seeking to maximize the utility of their credits through sales or transfers, certification is a mandatory first step. The North Dakota Department of Commerce manages the certification of “qualified research and development companies”.

To be certified, a taxpayer must meet the following criteria:

• Must be an individual, C-corporation, estate, or trust (S-corporations and partnerships are ineligible for the transfer provision at the entity level).
• Must be currently certified as a “Primary Sector Business”.
• Must have annual gross revenues of less than $750,000.
• Must be conducting research in North Dakota for the first time after December 31, 2016.
• Must apply using Form SFN 58638.

The Mechanics of Credit Transfer

The ability to transfer unused credits is a cornerstone of North Dakota’s support for technology startups. A certified company may sell, transfer, or assign up to a lifetime total of $100,000 of unused R&D tax credits.

The process requires the execution of a purchase agreement and the filing of Form CTS (Credit Transfer Statement). This form must be filed within thirty days of the agreement’s execution. The purchaser of the credit receives the same rights as the transferor, with the significant exception that they cannot carry the credit back to prior years. They may, however, carry it forward for up to 15 years.

Property Tax Clearance Requirement

A critical administrative hurdle often overlooked by taxpayers is the property tax clearance requirement codified in N.D.C.C. § 57-01-15.1. Before any state tax incentive, including the R&D credit, can be claimed, the taxpayer must demonstrate that they are in good standing with every North Dakota county in which they hold a fifty percent or greater interest in real property. This requirement extends to the corporation and its responsible officers. Failure to obtain this clearance can result in the immediate disallowance of the credit, regardless of the validity of the research expenditures.

Specialized Treatment for Passthrough Entities and Consolidated Groups

The North Dakota R&D tax credit is designed to accommodate various business structures, ensuring that the incentive flows to the ultimate taxpayers.

Passthrough Entity Allocation

For entities such as partnerships, LLCs treated as partnerships, and S-corporations, the credit is calculated at the entity level using either the regular or ASC method. The resulting credit is then passed through to the owners in proportion to their ownership interests.

Owners receive their allocated credit on their North Dakota Schedule K-1 (Form 58 for partnerships or Form 60 for S-corporations). Individual taxpayers then report these credits on Schedule ND-1TC. While the 50% tax liability limitation does not apply at the entity level, it is applicable to each individual owner’s tax return.

Consolidated Combined Returns

Corporate taxpayers filing a consolidated North Dakota return may apply the R&D credit against the aggregate tax liability of the entire group. This allows a research-heavy subsidiary to offset the profits of other entities within the same combined group. However, a significant restriction applies: this consolidated application does not extend to credits purchased from other taxpayers. Purchased credits are restricted to the tax liability of the specific entity that acquired them.

Carryback and Carryforward Provisions

North Dakota offers a generous carry-over period, allowing businesses to derive value from the credit even during years of unprofitability.

• Carryback: Unused credits must be carried back to the three preceding tax years. A claim for a carryback must be filed within three years of the original return’s due date for the year the credit was earned.
• Carryforward: Any remaining credit can be carried forward for up to 15 tax years.

Special rules apply to taxpayers who earned credits before January 1, 2007. These taxpayers are subject to a $2 million annual cap, and any amount earned in excess of this cap cannot be carried back or forward; it is simply lost. This provision serves as a grandfather clause for the older, more restrictive version of the credit.

Economic Impact and Statistical Perspective

The North Dakota Legislative Council and the Office of State Tax Commissioner periodically evaluate the fiscal and economic impact of the research expense credit. These studies provide a quantitative foundation for understanding the credit’s role in state development.

Historical Claimant Data (2007-2016)

A decade-long review revealed the following statistics regarding the credit’s usage and impact.

The review also highlighted a fiscal “loss” to the state budget of approximately $30 million over 20 years, when accounting for direct costs and the increased demand for public services due to population growth. Despite this budgetary net loss, the credit is widely viewed as a successful economic development tool due to its role in diversifying the economy and supporting high-wage industries.

State Spending and General Revenue Context

To understand the scale of the R&D credit, it is useful to view it within North Dakota’s broader fiscal landscape.

The concentration of R&D activity in the energy and agriculture sectors aligns with the state’s revenue sources. In 2022, North Dakota’s largest source of per capita revenue was severance taxes on oil and gas, amounting to $3,674 per person. The R&D credit facilitates the technological improvements necessary to maintain the efficiency and environmental compliance of these critical sectors.

Audit Risks and Substantiation Requirements

Given the complexity of the “North Dakota-only” sourcing requirement and the four-part test, the research expense credit is a frequent subject of review by state tax auditors. Taxpayers are advised to maintain a “contemporaneous record” of their R&D activities.

Common Audit Challenges

1. Sourcing of Contract Research: Auditors frequently scrutinize payments to third-party consultants. If a North Dakota company hires a Minnesota-based engineering firm, only the portion of the work actually performed within North Dakota borders is eligible.
2. Internal Software Development: While software development is a qualified activity, it must meet a higher “internal use” threshold if the software is not intended for sale or lease to third parties.
3. Indirect Support Wages: The inclusion of personnel in human resources, accounting, or legal departments is generally disallowed unless they are directly supporting a specific research project.
4. Base Period Consistency: For those using the regular method, auditors check that the methodology used to calculate the base period expenses is consistent with the methodology used for current-year expenses.

Recommended Documentation Checklist

To withstand a North Dakota tax audit, businesses should preserve the following documents for at least four years, though a 15-year period is recommended to support carryforwards:

• Project Lists: A comprehensive list of all R&D projects claimed for the year.
• Technical Descriptions: Documentation for each project explaining the uncertainty, the experimentation process, and the technological principles involved.
• Employee Time Tracking: Records (such as timesheets or project logs) that verify the percentage of time each employee spent on qualified activities.
• Supply Invoices: Invoices and general ledger detail for materials and supplies consumed in research.
• Contracts: Signed agreements with third-party researchers specifying the scope of work and the location where the work was performed.

Final Thoughts

The North Dakota Alternative Simplified Computation has successfully transitioned from a legislative proposal to a vital component of the state’s innovation ecosystem. By providing a calculation method that rewards current commitment to research over historical performance, the ASC makes the Research and Experimental Expenditure Tax Credit accessible to a wider array of businesses, from high-growth technology startups to established manufacturers pivotting into new markets.

For professional practitioners and business leaders, the ASC is more than a simplified formula; it is a strategic option that demands annual re-evaluation. The interplay of North Dakota-specific sourcing, the property tax clearance requirement, and the potential for credit transferability creates a nuanced environment where meticulous record-keeping and proactive tax planning are essential. As the state continues to rely on primary sector growth and technological advancement in its core energy and agricultural industries, the ASC will remain a primary vehicle for incentivizing the discovery of tomorrow’s solutions today.