Tiered Credit Rates

Tiered credit rates in the North Dakota research and development (R&D) tax credit refer to a stratified incentive structure where distinct percentage rates are applied to specific tranches of incremental research spending. This mechanism prioritizes early-stage innovation by applying a high 25% credit to the first $100,000 of excess qualified research expenses before transitioning to a lower secondary rate for expenditures beyond that threshold.

The North Dakota Research and Experimental Expenditure Tax Credit, primarily governed by North Dakota Century Code § 57-38-30.5, represents a sophisticated policy tool designed to stimulate technological advancement and economic diversification within the state. By utilizing a tiered rate system, the state government effectively targets smaller enterprises and startups with a potent front-loaded incentive while maintaining a sustainable secondary incentive for larger, capital-intensive organizations. This structure recognizes that the marginal utility of a tax credit is often highest for companies in their nascent growth phases, where a 25% return on the first $100,000 of new research spending can significantly impact cash flow and R&D runway. For larger corporations, particularly those in North Dakota’s dominant energy and agricultural sectors, the secondary tier ensures that massive, multi-million dollar projects still receive a meaningful 8% credit, thereby keeping the state competitive against national and international jurisdictions.

Statutory Foundations and the Evolution of the Tiered System

The legislative intent behind N.D.C.C. § 57-38-30.5 is to align North Dakota’s corporate tax environment with the federal standards established under Internal Revenue Code (IRC) § 41, while introducing state-specific modifications that prioritize local investment. The credit is fundamentally an “incremental” incentive, meaning it is not calculated on the total amount of research spending, but rather on the “excess” of current-year qualified research expenses (QREs) over a defined “base amount”. This ensures that state tax expenditures are directed toward encouraging new or increased research activities rather than subsidizing existing operations.

The tiered rates currently in effect are the product of several legislative reform cycles. Prior to 2007, the credit was arguably more restrictive, featuring a dual-rate system of 8% on the first $1.5 million of excess QREs and 4% on amounts exceeding that. The modernization of the statute in 2007 introduced the 25% primary tier for the first $100,000 of excess, reflecting a pivot toward supporting small business innovation. Over the following decade, the secondary tier rate underwent a phased transition, fluctuating based on the year research began and the specific tax year in question, eventually standardizing at 8% for all taxpayers starting in 2017.

Current Regular Method Tiered Rates

For most taxpayers conducting research today, the “Regular Method” provides a two-tiered calculation applied to North Dakota-sourced excess QREs.

Tier Level	Excess QRE Threshold	Credit Percentage Rate
Tier 1	First $100,000 of Excess QREs	25.0%
Tier 2	Excess QREs exceeding $100,000	8.0%

The primary tier provides a maximum credit of $25,000 for the first $100,000 of incremental spending. Any spending beyond this point enters the second tier, where every additional dollar of excess research generates 8 cents of tax credit. This bifurcation creates a declining marginal credit rate, which is a hallmark of policy designs intended to balance intensive support for small-scale innovation with fiscal responsibility for large-scale industrial projects.

The Mathematical Formula for Tiered Credits

To determine the credit amount under the Regular Method, tax professionals utilize a piecewise linear function based on the excess expenses:

If Excess is less than or equal to $100,000: Credit = 0.25 × Excess

If Excess is greater than $100,000: Credit = $25,000 + 0.08 × (Excess – $100,000)

This formula ensures that the transition between tiers is continuous, preventing “cliff” effects where a small change in spending results in a disproportionate change in tax liability.

Alternative Simplified Computation (ASC) Tiers

In 2019, the North Dakota Legislative Assembly introduced the Alternative Simplified Computation (ASC) method to provide taxpayers with an easier way to calculate their base amount, mirroring federal reforms. The ASC method is particularly advantageous for businesses that lack robust historical data for the standard base calculation or whose research spending is highly volatile.

Like the Regular Method, the ASC also utilizes a tiered rate structure, albeit with lower percentage points to account for the generally lower “base” hurdle.

ASC Tier Level	Alternative Excess QRE Threshold	ASC Credit Percentage Rate
ASC Tier 1	First $100,000 of Alternative Excess	17.5%
ASC Tier 2	Alternative Excess exceeding $100,000	5.6%

Under the ASC, the “base” is defined as 50% of the average QREs for the three preceding tax years. This methodology provides a more immediate benchmark for current research growth. For instance, a firm that increases its research budget significantly following a period of stagnation may find the ASC tiered rates more lucrative than the Regular Method tiers.

Tiers for Entities with Zero Prior-Year Expenses

A critical subset of the ASC tiered system applies to companies that did not incur QREs in at least one of the three preceding tax years. In these cases, the credit is calculated as a percentage of the total current-year QREs, but the rates are reduced to prevent excessive credit generation for companies merely starting up without an “incremental” growth baseline.

Zero-Year ASC Tier	Current-Year QRE Threshold	Applicable Rate
Tier 1	First $100,000 of Total QREs	7.5%
Tier 2	Total QREs exceeding $100,000	2.4%

This non-incremental tiered structure ensures that the state continues to incentivize nascent research efforts while acknowledging that these companies do not yet meet the statutory definition of “increasing” research over a three-year history.

Local Revenue Office Guidance and Application of Law

The North Dakota Office of State Tax Commissioner serves as the primary regulatory body overseeing the administration of the Research and Experimental Expenditure Tax Credit. Guidance issued by the Tax Commissioner emphasizes the strict geographic requirements and the procedural steps necessary to claim the credit across different entity types.

Geographic Sourcing Guidance

A recurring theme in the official guidance is the “North Dakota Source” requirement. While N.D.C.C. § 57-38-30.5 largely adopts the federal definitions of “qualified research” and “qualified research expenses,” it explicitly excludes any expenses incurred for research conducted outside the state of North Dakota. Furthermore, the “base amount” calculation must only include gross receipts and research expenses attributable to North Dakota activity.

For businesses with multi-state operations, the Tax Commissioner provides the following interpretative guidance:

• Wages: Only the portion of an employee’s wages corresponding to research activities performed physically within North Dakota is eligible.
• Contract Research: 65% of payments to third parties are eligible only if the research services were performed within North Dakota state lines.
• Supplies: Only supplies consumed or used in the conduct of research within North Dakota are includable.

Guidance for Passthrough Entities

Because a significant portion of North Dakota’s business landscape consists of S Corporations, Limited Liability Companies (LLCs), and Partnerships, the Tax Commissioner provides specific instructions for the allocation of tiered credits.

Under the guidance, the credit is calculated at the entity level based on the entity’s total North Dakota QREs and its historical base. Once the total credit is determined using the tiered rates, it is passed through to the individual partners, shareholders, or members in proportion to their ownership interest. This allows the high 25% primary tier benefit to be distributed among owners to offset their individual North Dakota income tax liabilities.

Passthrough Entity Type	Tax Return Used	Schedule for Credit Allocation
S Corporation	Form 60	Schedule K
Partnership	Form 58	Schedule K
Fiduciary (Trust/Estate)	Form 38	Schedule 38-TC

Owners then report their share of the credit on their personal North Dakota returns, typically using Schedule ND-1TC for individuals.

Property Tax Clearance Requirement

A unique administrative hurdle highlighted in state guidance is the “Property Tax Clearance Record”. To qualify for the Research and Experimental Expenditure Tax Credit, a taxpayer must obtain a record from the local county treasurer confirming that all property taxes due have been paid. This requirement reflects a legislative policy of ensuring that companies receiving state income tax incentives are also meeting their local tax obligations. Failure to provide this clearance can lead to the disallowance of the credit, regardless of the validity of the research expenditures.

Historical Tiered Rates and Legacy Taxpayer Limitations

For tax professionals managing long-standing North Dakota corporations, understanding the historical tiered rates is essential, as the statute maintains distinct rules for “legacy” taxpayers—those who earned or claimed the credit before January 1, 2007.

The $2 Million Annual Ceiling

Taxpayers who fall into the legacy category are subject to a maximum credit cap of $2 million per taxable year. Critically, any credit amount calculated in excess of this $2 million threshold is permanently disallowed; it cannot be carried back or forward to other tax years. This contrasts sharply with “new” taxpayers (those starting research after 2006), who face no annual cap on credit generation.

Phased Secondary Tier Rates (2007-2016)

For the decade following the 2007 overhaul, the secondary tier percentage (the rate for excess over $100,000) was not static. The rate depended on whether the research was established before or after 2007, creating a complex compliance landscape during that period.

Tax Year	Pre-2007 Research Secondary Rate	Post-2007 Research Secondary Rate
2007	7.5%	20.0%
2008	11.0%	20.0%
2009	14.5%	20.0%
2010-2016	18.0%	20.0%
2017-Present	8.0%	8.0%

The high 20% secondary rate for new research entities between 2007 and 2016 was a major driver of corporate relocations to North Dakota during that era. However, the state eventually lowered this rate to 8% to ensure the program’s long-term sustainability while maintaining the high 25% “entry” tier for small-scale innovation.

Example Calculation: Regular Method Tiers

To provide a concrete application of the tiered rate structure, consider a North Dakota manufacturing company, “Prairie Tech Innovations,” which has seen significant growth in its R&D department.

Assumptions:

• Current Year North Dakota QREs: $650,000
• Calculated North Dakota Base Amount: $400,000
• Taxpayer is not a legacy (pre-2007) claimant.

Step 1: Determine the Excess QREs

The excess is the current year spend minus the base amount.

Excess = $650,000 – $400,000 = $250,000

Step 2: Apply the Tiered Rates

The first $100,000 is taxed at the primary rate, and the remaining $150,000 is taxed at the secondary rate.

• Tier 1 Credit: $100,000 × 25% = $25,000
• Tier 2 Credit: $150,000 × 8% = $12,000

Step 3: Calculate Total Credit

Total Credit = $25,000 + $12,000 = $37,000

In this scenario, Prairie Tech Innovations earns a total state credit of $37,000. This represents a blended effective credit rate of 14.8% on their incremental research spending. Without the tiered structure (e.g., if a flat 8% rate were used), the credit would only be $20,000. The tiered system provides an extra $17,000 in benefit specifically rewarding the first $100,000 of growth.

Example Calculation: ASC Method Tiers

Assume the same company, Prairie Tech Innovations, elects to use the Alternative Simplified Computation (ASC) method for the 2024 tax year.

Assumptions:

• Current Year North Dakota QREs: $650,000
• Average North Dakota QREs for prior 3 years: $500,000

Step 1: Calculate the ASC Base

The ASC base is 50% of the three-year average.

ASC Base = $500,000 × 50% = $250,000

Step 2: Calculate Alternative Excess

Alternative Excess = $650,000 – $250,000 = $400,000

Step 3: Apply ASC Tiered Rates

• ASC Tier 1 Credit: $100,000 × 17.5% = $17,500
• ASC Tier 2 Credit: $300,000 × 5.6% = $16,800

Step 4: Total ASC Credit

Total ASC Credit = $17,500 + $16,800 = $34,300

While the ASC method results in a slightly lower credit in this specific example ($34,300 vs $37,000), it provides a simpler calculation path and may be more beneficial if the company’s traditional base amount were higher.

The Role of the Department of Commerce and Credit Transferability

A highly specialized aspect of the North Dakota tiered credit system is the ability for small, primary sector businesses to sell or transfer their unused credits. This provision is overseen by the North Dakota Department of Commerce rather than the Tax Commissioner, requiring a separate certification process.

Qualification for Tiered Credit Transfer

The transferability provision is designed to provide liquidity to startups that are investing heavily in research but do not yet have the tax liability to utilize the 25% primary tier credit. To be eligible to sell, transfer, or assign up to $100,000 of credits, a company must meet the following criteria:

• Primary Sector Certification: The business must be certified by the Department of Commerce as a “primary sector business”—defined as a business that adds value to a product, process, or service through the employment of knowledge or labor, resulting in the creation of new wealth.
• Revenue Threshold: The business must have annual gross revenues of less than $750,000.
• New Innovation: The company must be conducting qualified research in North Dakota for the first time after December 31, 2006.
• Legal Entity Limitation: Only individuals, C Corporations, estates, or trusts may transfer credits. Partnerships and S Corporations are not eligible for entity-level transfers.

Mechanics of the Transfer

Qualified companies must apply for certification using Form SFN 58638. Once certified, the taxpayer can transfer all or part of their unused tiered credit to another taxpayer who has North Dakota liability. Both the transferor and the transferee must jointly file Form CTS (Credit Transfer Statement) within 30 days of the transaction. This mechanism effectively converts the tax credit into a cash-equivalent grant for the startup, while the purchaser receives the right to reduce their own state tax bill.

Strategic Implications of Tiered Rates for Business Planning

The tiered structure of the North Dakota R&D credit necessitates a strategic approach to capital allocation and research timing. Because the marginal benefit of the credit decreases after the first $100,000 of excess spend, businesses must carefully evaluate their R&D ROI at different expenditure levels.

Optimization of Research Timing

For mid-sized firms, the “sweet spot” for the credit is the first $100,000 of incremental growth, which yields a significant 25% return. Companies may find it advantageous to pace their research projects to ensure they hit this threshold consistently each year, rather than lumping all growth into a single tax period where the majority of the spend would only yield 8%.

Interaction with Federal Amortization Rules

Under recent federal tax changes (IRC Section 174), R&D expenses must now be capitalized and amortized over 5 years (for domestic research) or 15 years (for foreign research) rather than being expensed immediately. While this creates a tax burden at the federal level, the North Dakota credit—being based on expenditures rather than deductions—continues to provide immediate relief through its tiered rates. This makes the 25% state credit even more valuable in the current high-interest, capitalized-expense environment, as it provides immediate cash flow offsets while the federal deductions are deferred.

Comparative Analysis: North Dakota vs. Regional Neighbors

When viewed in a regional context, North Dakota’s tiered R&D credit is exceptionally aggressive in its primary tier, signaling a strong desire to compete for early-stage tech and biotech firms.

State	Primary Tier Rate	Tier Cap	Secondary Tier Rate
North Dakota	25.0%	$100,000	8.0%
Arizona	24.0%	$2,500,000	15.0%
Minnesota	10.0%	$2,000,000	2.5%
Indiana	15.0%	$1,000,000	10.0%

North Dakota offers the highest primary tier percentage among these states. While states like Arizona and Indiana offer their high rates over much larger tranches of spending (making them more lucrative for very large research hubs), North Dakota’s 25% rate on the first $100,000 is an unparalleled incentive for small companies and startups. This confirms North Dakota’s strategic focus on diversifying its economy by nurturing small, high-growth primary sector businesses.

Compliance, Audit Readiness, and Documentation Standards

The North Dakota Office of State Tax Commissioner emphasizes that while the credit is non-refundable (unless transferred by a qualified entity), it is subject to rigorous audit standards. Taxpayers are expected to maintain documentation that substantiates both the technical qualification of the research and the geographic sourcing of the expenses.

Documentation of the Four-Part Test

To survive a state audit, a company must prove that its research meets the federal four-part test as defined in IRC § 41(d):

• Technological in Nature: The research must rely on principles of physical or biological science, engineering, or computer science.
• Permitted Purpose: The research must be for the development of a new or improved business component.
• Elimination of Uncertainty: There must be uncertainty regarding the capability, method, or design of the component.
• Process of Experimentation: Substantially all of the activity must involve a process of evaluating alternatives through testing or trial and error.

In the context of North Dakota’s economy, this often translates to research in precision agriculture (e.g., autonomous harvesting software), energy extraction techniques (e.g., carbon capture technologies), or advanced manufacturing automation.

Record Retention Requirements

The state recommends a four-year retention period for all R&D-related records. This includes:

• Payroll Records: Detailed time-tracking logs showing the percentage of time each employee spent on qualified research activities within the state.
• Supply Invoices: Proof that materials were purchased for and consumed during the research process in North Dakota.
• Contractual Agreements: Explicit contracts with third-party researchers specifying that the work was performed within North Dakota and that the taxpayer retains the intellectual property rights.

Failure to maintain these records can result in the full recapture of the credit, plus interest and penalties.

Fiscal and Economic Impact of the Tiered System

The tiered R&D credit plays a significant role in North Dakota’s broader fiscal strategy. By targeting specific sectors—most notably the “primary sector”—the state ensures that tax incentives are driving the creation of “new wealth” rather than simply shifting existing economic activity.

Statistics and Industry Utilization

While specific biennial totals for the R&D credit are managed by the Tax Commissioner’s office, broader economic data indicates that the primary sectors receiving the most benefit are oil and gas extraction, machinery manufacturing, and large-scale farming.

Industry Sector	GDP Contribution in ND (2023)	Strategic Relevance to R&D
Oil & Gas Extraction	9.8%	High (extraction/emissions research)
Farms	High	High (precision ag/crop science)
Machinery Manufacturing	Overperforming vs National Avg	High (automation/robotics)

The tiered rates are particularly effective for the machinery manufacturing sector, where a small firm developing a single robotic component can hit the 25% primary tier quickly, significantly reducing its state tax burden.

Impact on State Revenues

The state budget for the 2024-2025 biennium reported approximately $6.1 billion in general fund spending. Tax incentives, including the R&D credit, are considered “tax expenditures” that reduce this general fund revenue. However, the tiered structure acts as a natural stabilizer; because the rate drops to 8% after the first $100,000, the state’s fiscal exposure to massive corporate R&D shifts is capped at a lower rate, preventing an unsustainable drain on state coffers while still encouraging top-tier innovation.

Final Thoughts

The North Dakota Research and Experimental Expenditure Tax Credit, through its tiered rate structure, offers a compelling and sophisticated value proposition for businesses. By prioritizing the first $100,000 of incremental research with a 25% credit, the state has created a highly hospitable environment for the “innovation economy,” particularly for the startups and mid-sized enterprises that form the backbone of a diversified state economy.

The administrative complexity of the tiered system—encompassing both the Regular and ASC methods, legacy taxpayer caps, and Department of Commerce certifications—requires diligent tax planning. However, the rewards for such diligence are significant. For qualified research and development companies, the ability to monetize these credits via transferability provides a vital infusion of capital during the most critical stages of growth. For larger established entities, the 8% secondary tier and the 15-year carryforward provision ensure that North Dakota remains a viable long-term hub for industrial research and technological evolution.

As North Dakota continues to lead in energy production and agricultural innovation, the tiered R&D credit will remain a central pillar of its economic identity, fostering a culture where new ideas are not just welcomed, but aggressively incentivized through a thoughtful and stratified tax policy. For any business operating within the state, a thorough understanding of these tiered rates is not merely a matter of compliance, but a strategic necessity for maximizing the return on investment in the future of technology.