California State R&D Tax Credits

California’s R&D Tax Credit offers substantial financial incentives to businesses that invest in research and development activities. Designed to encourage innovation and economic growth, the credit can significantly reduce your state tax liability. Here’s a comprehensive guide to understanding and claiming this benefit. 

What Is the California R&D Tax Credit? 

The California R&D Tax Credit allows businesses to offset a portion of their state income or franchise tax liability using a credit based on their California qualified research expenses (QREs). This credit is closely aligned with the federal R&D Tax Credit but includes several unique state-specific provisions.

Who Qualifies for the California R&D Tax Credit? 

Your business may qualify for the California R&D Tax Credit if it: 

• Engages in R&D activities that meet the federal definition under Section 41 of the Internal Revenue Code. 
• Incurs QREs within California. These expenses typically include employee wages, supplies, and contract research costs directly related to qualified research activities. 
• Aims to develop or improve products, processes, software, or inventions. 

Both large and small businesses across various industries, including technology, manufacturing, consumer products, and biotechnology, can take advantage of this credit. 

How to Calculate the Credit 

• When using the regular method of calculation, California’s R&D credit closely aligns with the federal credit, applying a fixed base percentage determined from historical gross receipts and R&D spend.   
• However, one difference is that California’s definition of “gross receipts” is different than the federal definition. California defines gross receipts as the sale of real, tangible, or intangible property held for sale to customers and delivered to a purchaser within California. This limited definition means receipts related to license payments are generally excluded from the R&D tax credit calculation.  
• The state R&D credit in California is generally equal to 15% of qualified expenses that exceed a base amount. Businesses claim this state credit on Form FTB 3523 with their business return.  

In the event that the state credit exceeds tax liability or can otherwise not fully be utilized, unused credits can be carried forward indefinitely. 

Applying for the California R&D Tax Credit 

1. Determine Eligibility: Ensure your R&D activities and expenses meet both federal and California-specific requirements. 
2. Calculate QREs: Compile detailed records of your qualified research expenses, such as payroll, supply costs, and contract research fees. 
3. Claim the Credit on Tax Return: Use California’s Form 3523, “Research Credit,” to claim the R&D tax credit when filing your state tax return.  
4. Carry Forward Unused Credits: If your business cannot use the full credit in the current tax year, California allows unused credits to be carried forward indefinitely. 

Key Differences Between California and Federal R&D Credits 

• No Alternative Simplified Credit (ASC): Unlike the federal credit, California does not offer an ASC calculation method, but does provide an alternative incremental method.  The election to use this method is a permanent election and requires approval from the California Franchise Tax Board to be revoked for future years. 
• Higher Basic Research Credit Rate: California’s rate of 24% for university research is higher than the federal rate. 
• No Refundable Credit: The California R&D Tax Credit is nonrefundable, meaning it can only offset state tax liability. 

Tips for Maximizing the Credit 

• Coordinate with Federal Credits: By aligning your California claim with your federal R&D Tax Credit, you can maximize savings across both levels. 
• Maintain Substantial Documentation: Keep detailed records of your R&D activities and expenses, including time-tracking systems, project descriptions, and financial data. 
• Work with Experts: Partnering with R&D tax credit professionals or CPAs who specialize in state credits can help ensure compliance and maximize your claim. 

The California R&D Tax Credit provides an excellent opportunity for businesses to reduce their tax burden while investing in innovation. By understanding the program’s requirements and taking the right steps to apply, you can unlock significant financial benefits. Don’t miss out on this opportunity to reinvest in your business and drive growth—start exploring how you can claim the California R&D Tax Credit today!