Credit Percentage (25%)

The North Dakota Research and Experimental Expenditure Tax Credit provides an income tax credit equal to 25 percent of the first $100,000 of qualified research expenses exceeding a base amount. This specialized incentive is designed to reduce the net cost of innovation for businesses conducting technological or scientific research within the state’s borders.

The 25 percent credit percentage serves as the primary gateway for incentivizing early-stage research and development (R&D) within the state of North Dakota, representing one of the most aggressive state-level tax incentives for innovation in the United States. While many states offer flat-rate credits or incentives tied strictly to federal liability, North Dakota’s tiered structure—governed by North Dakota Century Code (N.D.C.C.) § 57-38-30.5—prioritizes the initial tranche of spending to maximize the benefit for small to mid-sized enterprises (SMEs) and startups. This analysis explores the legislative history, the complex interplay between state and federal definitions, the administrative requirements mandated by the Office of State Tax Commissioner, and the economic efficacy of this fiscal tool. To understand the 25 percent credit, one must first look at the mechanism of “excess” qualified research expenses (QREs), which distinguishes North Dakota’s approach from simpler investment-based credits.

Statutory Authority and the Evolution of the Tiered Rate System

The legal foundation for the North Dakota Research and Experimental Expenditure Tax Credit is located within the state’s income tax statutes under N.D.C.C. § 57-38-30.5. The North Dakota Legislative Assembly originally enacted this provision in 1987 via House Bill No. 1645. At its inception, the credit was patterned after a successful Minnesota model, which sought to encourage existing corporations to expand their R&D footprints while attracting new entities into the regional market. The initial design of the credit provided for an 8 percent credit on the first $1.5 million of North Dakota qualified research expenses in excess of base period research expenses, and 4 percent for any amount exceeding $1.5 million.

The 2007 Legislative Restructuring

A pivotal shift in the state’s innovation policy occurred during the 2007 legislative session. Through the passage of House Bill Nos. 1412 and 1018, the Legislative Assembly undertook a substantial restructuring of Section 57-38-30.5. This reform was driven by the desire to pivot the incentive toward smaller businesses and primary sector startups. The restructuring introduced the 25 percent credit rate for the first $100,000 of excess qualified research expenses, effectively “front-loading” the incentive. This change ensured that a company spending its first $100,000 over its historical base would receive a significant $25,000 tax offset, whereas previously, that same expenditure would have yielded only $8,000 in credit.

For the years following 2007, the second-tier rate—the percentage applied to excess expenses above the first $100,000—varied based on when the taxpayer first began conducting qualified research in the state. For those who started before 2007, the secondary rate gradually increased over a decade. However, for modern taxpayers (those beginning research after 2010 or 2016), the second-tier rate was eventually standardized at 8 percent.

Defining the “25 Percent” Mechanism: The Regular Method

The meaning of the 25 percent credit percentage is intrinsically tied to the “Regular Method” of calculation. To determine the credit amount, a taxpayer must identify their “Excess Qualified Research Expenses.” This is not simply 25 percent of all research spending, but rather 25 percent of the delta between current-year spending and a calculated baseline.

The Calculation of Qualified Research Expenses (QREs)

North Dakota adopts the federal definitions provided in Section 41 of the Internal Revenue Code (I.R.C.) to maintain administrative alignment. Specifically, N.D.C.C. § 57-38-30.5 references I.R.C. § 41(b) for the definition of “qualified research expenses.” These expenses typically include:

In-House Research Expenses: These are primarily wages paid to employees who are directly performing, supervising, or supporting research activities. It also includes the cost of supplies used in the conduct of qualified research.

Contract Research Expenses: This includes 65 percent of amounts paid to a third party for qualified research conducted on the taxpayer’s behalf.

The critical North Dakota-specific limitation is that only expenses incurred for research conducted within the state of North Dakota qualify for the state credit. If a company has researchers in both Fargo, ND, and Minneapolis, MN, only the wages and supplies attributable to the Fargo facility may be included in the calculation.

Determining the Base Amount

The 25 percent rate is applied only to the amount of QREs that exceed the “North Dakota Base Amount.” Following I.R.C. § 41(c), the base amount is generally the product of a “fixed-base percentage” and the average annual gross receipts for the four preceding years. For the purposes of the North Dakota credit, the gross receipts must be limited to those attributable to North Dakota.

Furthermore, the law mandates a “minimum base amount” (often called the 50 percent rule). The base amount cannot be less than 50 percent of the current year’s QREs. This ensures that companies with extremely low historical spending still have a significant portion of their current spending excluded from the 25 percent calculation, preventing the credit from becoming an “all-spending” subsidy.

The Tiered Rate Formula

Once the excess QREs are calculated, the 25 percent rate is applied to the first $100,000 of that excess. The mathematical expression of the credit under the regular method is as follows:

Credit = (0.25 × min(Excess QRE, 100,000)) + (0.08 × max(0, Excess QRE – 100,000))

This formula ensures that the marginal benefit is highest for the first $100,000 of incremental innovation.

Alternative Simplified Computation (ASC) Method

Beginning in the 2019 tax year, North Dakota introduced a secondary path for taxpayers: the Alternative Simplified Computation (ASC) method. This method was added via legislative updates to provide a less burdensome calculation for companies that lack the decades-old historical records required for the regular method or those whose revenue growth has made the regular method’s base amount prohibitively high.

Under the ASC method, the credit percentages are adjusted. The ASC does not use a 25 percent rate; instead, it uses a 17.5 percent rate for the first $100,000 of “alternative excess” and 5.6 percent for the remainder.

Calculation of Alternative Excess

The ASC base is much simpler to compute. It is 50 percent of the average qualified research expenses incurred in North Dakota for the three tax years immediately preceding the year the credit is claimed.

Alternative Excess = Current QRE – (0.50 × Avg. QRE of 3 Prior Years)

If a taxpayer did not have research expenses in any of the three prior years, the law provides a further simplified rate: 7.5 percent of the first $100,000 of current year QREs and 2.4 percent of the excess over $100,000.

The taxpayer may elect to use either the regular method or the ASC method on a year-to-year basis. This election is binding for the tax year in which it is made. This flexibility is a hallmark of North Dakota’s business-friendly tax environment, allowing companies to pivot their tax strategy as their R&D and revenue profiles change.

Local State Revenue Office Guidance and Documentation

The Office of State Tax Commissioner (OSTC) serves as the primary regulatory body for the administration of the research expense tax credit. The OSTC provides guidance through official tax booklets, instructions, and various forms tailored to different types of taxpayers.

Filing Requirements by Entity Type

North Dakota’s R&D credit is available across various tax structures. The method of claiming the credit depends on whether the taxpayer is an individual, a corporation, or a passthrough entity.

C Corporations: Claim the credit on Form 40 (Corporation Income Tax Return) and utilize Schedule TC to report the credit amount. Corporate groups filing a consolidated combined return may apply the credit against the aggregate tax liability of the group, provided the credit was earned by the group and not purchased.

S Corporations and Partnerships: These are passthrough entities. The credit is calculated at the entity level and then passed through to the owners, shareholders, or partners in proportion to their respective interests. For S Corporations, the credit is reported on Form 60, Schedule K. For Partnerships, it is reported on Form 58, Schedule K.

Individuals and Sole Proprietors: These taxpayers claim the credit on Schedule ND-1TC, which is attached to their individual income tax return (Form ND-1).

Fiduciaries (Estates and Trusts): Fiduciaries use Form 38 (Fiduciary Income Tax Return) and calculate the credit on Schedule 38-TC. Fiduciaries must also provide beneficiaries with a Schedule K-1 (Form 38), which details the beneficiary’s share of the credit.

Mandatory Attachments and Worksheets

The Office of State Tax Commissioner does not have a single, dedicated state form for the R&D calculation like the federal Form 6765. Instead, taxpayers are required to attach their own schedule or worksheet that clearly demonstrates the computation of the credit, including the calculation of the base amount and the application of the tiered 25 percent and 8 percent rates.

Critical documentation for the OSTC includes:

• A breakdown of North Dakota-specific QREs (Wages, Supplies, and 65% of Contract Research).
• A four-year history of North Dakota gross receipts for the regular method, or a three-year history of North Dakota QREs for the ASC method.
• Evidence that the research was performed within the state.

Administrative Limitations and Historical Caps

The North Dakota R&D credit contains specific limitations that primarily affect long-standing taxpayers who were active before the 2007 reforms.

The $2 Million Annual Cap

For any taxpayer who first earned or claimed a credit in North Dakota before January 1, 2007, the maximum credit allowed in any single year is $2 million. This cap is a “hard” limit—any credit earned in excess of $2 million by these taxpayers cannot be used in the current year, and critically, the excess cannot be carried back or forward. This effectively discourages large, legacy corporations from monopolizing the state’s tax expenditure budget for R&D.

However, for taxpayers who began their research in North Dakota on or after January 1, 2007, there is no such annual cap on the amount of credit that can be earned, though the nonrefundable nature of the credit and the limitations of tax liability still apply.

Carryback and Carryforward Rules

If the calculated research credit exceeds a taxpayer’s actual income tax liability for the year, the credit is not lost. North Dakota provides a generous window for utilizing unused credits:

• 3-Year Carryback: The unused portion must first be carried back to each of the three preceding tax years to offset prior tax paid and generate a refund.
• 15-Year Carryforward: If the credit is not exhausted after the carryback, it can be carried forward for up to 15 years.

A claim for a carryback must be filed within three years of the due date (including extensions) of the tax return for the year in which the credit was earned. This aligns with the federal standard and provides a stable 18-year period for companies to recover their R&D investments.

Transferability and the Primary Sector Focus

A unique and powerful feature of the North Dakota R&D credit is the ability of certain companies to sell their credits. This is specifically designed to provide cash to pre-revenue or low-revenue startups that have no tax liability to offset.

Qualified Research and Development Companies

To transfer a credit, a taxpayer must be certified by the North Dakota Department of Commerce as a “qualified research and development company.” To obtain this certification, the entity must meet the following criteria:

• Primary Sector Business: It must be 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 includes manufacturing, food processing, and specialized technology services.
• New Research: It must have conducted qualified research in North Dakota for the first time after December 31, 2006.
• Revenue Limit: It must have annual gross revenues of less than $750,000.

The Transfer Mechanism (Form CTS)

A qualified company may sell, transfer, or assign up to $100,000 of its unused tax credits to another North Dakota taxpayer. This process requires the following administrative steps:

Certification: Apply to the North Dakota Department of Commerce (Division of Economic Development and Finance) for certification as a qualified R&D company.

Form CTS: The transferor (the startup) and the transferee (the buyer) must jointly complete and file Form CTS (Credit Transfer Statement) with the Office of State Tax Commissioner.

Deadline: Form CTS must be filed within 30 days after the date the credit transfer agreement is executed.

The purchaser of the credit claims it on their own tax return, beginning in the year the agreement was executed. While the purchaser cannot carry the credit back, they retain the 15-year carryforward rights. The transferor must report any proceeds from the sale as North Dakota income.

Practical Example: The Tiered Credit Calculation

To visualize how the 25 percent rate applies in practice, consider a hypothetical North Dakota-based energy technology firm, “Bismarck Bio-Solutions.”

Step 1: Establish the QREs and Base Amount

In the current tax year, Bismarck Bio-Solutions spends $450,000 on engineers’ wages and $50,000 on lab supplies in its Grand Forks facility.

• Total Current QREs: $500,000
• North Dakota Gross Receipts (Avg. 4 Years): $2,000,000
• Fixed-Base Percentage: 10%
• Calculated Base Amount: $200,000 ($2M x 10%)
• Check Minimum Base: 50% of Current QREs = $250,000.

Because the minimum base ($250,000) is higher than the calculated base ($200,000), the taxpayer must use $250,000 as their base amount.

Step 2: Calculate Excess Expenses

• Excess QREs: Current QRE ($500,000) – Base Amount ($250,000) = $250,000 in Excess.

Step 3: Apply the Tiered Credit Rates

First $100,000 of Excess: $100,000 x 25% = $25,000

Remaining Excess over $100,000: Remaining Excess = $250,000 – $100,000 = $150,000. $150,000 x 8% = $12,000

Total North Dakota R&D Credit: $25,000 + $12,000 = $37,000

In this scenario, Bismarck Bio-Solutions receives a total credit of $37,000. If they have no tax liability, they could potentially sell $37,000 of this credit (since it is under the $100,000 transfer cap) to another company if they meet the “Primary Sector” and revenue requirements.

Statistical Analysis of Credit Usage and Fiscal Impact

The effectiveness of the research expense tax credit can be analyzed through data provided by the Tax Department and reported by the Legislative Council. Usage statistics indicate a clear upward trend in the adoption of the credit since the 2007 reforms.

Historical Claims Data

The following table summarizes the growth of the credit across individual and corporate tax filers during the years surrounding the transition to the 25 percent tier.

The data shows that while more individuals claim the credit (likely through passthrough entities like S-Corps and LLCs), the corporate filers account for a disproportionately high amount of the total dollar volume. For instance, in 2012, only 16 corporate returns accounted for over $6.5 million in credits, suggesting that large industrial players in the energy and agriculture sectors are major beneficiaries of the incentive beyond the first $100,000 tier.

Fiscal Impact on the General Fund

The expansion of the R&D credit has a direct impact on the state’s general fund. In the 2007-09 biennium, the restructuring was estimated to reduce state revenues by approximately $2.47 million. However, proponents argue that the credit facilitates economic outcomes such as business growth, employment opportunities, and economic diversity. The Legislative Management interim committee is tasked with reviewing these data points to ensure the fiscal impact is balanced against the perceived goals of retention and attraction of primary sector businesses.

Audit Guidelines and Compliance Standards

Claiming the 25 percent R&D tax credit carries a significant responsibility for documentation and audit defense. Because the credit uses federal definitions, the North Dakota Office of State Tax Commissioner often follows federal audit guidelines when examining a claim.

The Four-Part Test for Qualified Research

To survive an audit, every activity for which expenses are claimed must meet the I.R.C. § 41 four-part test. The OSTC requires documentation that proves:

Permissible Purpose: The research must relate to a new or improved function, performance, reliability, or quality of a business component.

Technological in Nature: The research must fundamentally rely on the principles of physical or biological science, engineering, or computer science.

Elimination of Uncertainty: At the outset of the project, the taxpayer must demonstrate that they lacked the information to determine if the goal was possible, or how it could be achieved.

Process of Experimentation: The taxpayer must evaluate one or more alternatives through a systematic process (e.g., modeling, simulation, or trial and error).

Record Retention Requirements

Taxpayers should retain records for at least four years, though a longer period is advisable if credits are being carried forward. Essential records include:

• Project Lists: A comprehensive list of all R&D projects undertaken in the tax year.
• Employee Records: Timesheets or allocation percentages for individuals whose wages are claimed.
• Expense Substantiation: Invoices for supplies and contracts specifically for ND-based research.
• Technical Documentation: Design documents, lab notes, test results, and meeting minutes that prove the “process of experimentation.”

Comparison with Regional State Incentives

North Dakota’s R&D credit is often compared to its neighbors in the “Red Book”—the state’s comparative guide to taxes. While North Dakota has a lower overall income tax rate than many of its neighbors (recently reduced to a 2.5% top rate for individuals), its R&D credit remains a key differentiator.

The state’s 25 percent tier is significantly higher than the federal rate (which is effectively much lower due to the Section 280C(c) adjustment and other limitations) and is more aggressive than Minnesota’s 10 percent credit (up to $2 million) for similar research expenditures.

This high-intensity R&D credit serves to “buy down” the risk of innovation in a state that is geographically distant from major tech hubs like Silicon Valley or Boston.

Impact of Federal Tax Law Changes (OBBBA 2025)

The landscape of North Dakota tax law is constantly influenced by federal changes, as the state calculation begins with federal taxable income. The “One Big Beautiful Bill Act” (OBBBA), signed in July 2025, made many federal tax provisions permanent.

While federal tax credit changes do not directly impact the state R&D calculation (as the state uses its own tiered rates), federal changes to deductions for R&D can affect the starting point for state taxable income. For example, federal requirements to amortize R&D expenses over five years (under Section 174) rather than deducting them immediately have created a disconnect between tax liability and cash flow for many businesses. North Dakota’s 25 percent credit acts as a vital buffer against these federal changes, providing immediate state-level relief even when federal deductions are deferred.

Sector-Specific Considerations for North Dakota Research

The 25 percent credit has been strategically deployed in sectors that are critical to North Dakota’s economic identity.

Agriculture and Bio-processing

North Dakota’s “Primary Sector” designation includes many agricultural businesses. Research in this sector often qualifies for the 25 percent credit when it involves:

• Developing new food processing techniques that increase the shelf-life or nutritional value of North Dakota crops (e.g., wheat, soybeans, sugar beets).
• Precision agriculture software that uses satellite data to optimize fertilizer and water usage.
• Mechanical engineering for new types of harvesting or seeding equipment.

Energy and Carbon Capture

With the rise of renewable energy and the ongoing importance of the Bakken oil formation, R&D in the energy sector is a major driver of credit usage.

• Enhanced Oil Recovery (EOR): Testing new chemical injections to extract more petroleum from existing wells.
• Carbon Capture and Storage (CCS): Scientific research into the sequestration of CO2 in North Dakota’s unique geological formations.
• Wind and Biofuels: Improving the efficiency of wind turbine blades or the blending of green diesel fuels.

The Strategic Future of the 25 Percent Credit

As North Dakota continues to diversify its economy away from a pure reliance on commodity prices, the R&D credit will likely remain a cornerstone of its fiscal policy. The shift toward the Alternative Simplified Computation (ASC) suggests a move toward modernization and ease of use, making the credit accessible to a new generation of digital-first entrepreneurs who may not have the historical gross receipts data required for the Regular Method.

Furthermore, the state’s recent move to a zero-percent tax bracket for a substantial portion of individual income tax may change the “utility” of the credit for some very small passthrough entities. However, for any business with a growing tax liability, the 25 percent tier remains an essential tool for reinvesting profits into future innovation.

Summary and Final Thoughts

The 25 percent Credit Percentage in North Dakota is more than just a number; it is a calculated legislative preference for supporting the first steps of a company’s innovation journey. By providing $25,000 in tax relief for the first $100,000 of incremental research spending, North Dakota ensures that even the smallest primary sector business can afford to take technical risks.

For taxpayers and their advisors, the key to maximizing this benefit lies in understanding the rigorous documentation requirements and the specific state-nexus rules. Whether choosing the Regular Method or the ASC, and whether utilizing the 18-year carry window or the transferability option for startups, North Dakota’s Research and Experimental Expenditure Tax Credit provides a flexible and powerful mechanism for fostering a culture of technological advancement. As the state moves further into the 2025-2027 biennium, the credit stands as a testament to the North Dakota Legislative Assembly’s long-term commitment to economic resilience through localized innovation.