Posted by William Mehi on 09.01.21

Like the federal research and development (R&D) tax credit, the state of California provides a tax credit as an incentive to those who conduct research and development activities within the state. In fact, the 15% credit rate (regular credit only) for excess expenditures over a base, is one of the best credits in the nation. While the state and federal credits share some common requirements and incentives, the California Research Credit has some separate requirements.

Overview

The California Research Credit reduces the income or franchise tax of those taxpayers who engage in qualified research activities in California. Qualified research expenses generally include wages, supplies and contract research costs. Since 1987, the credit rate for basic research has doubled from 12% to 24% and the rate for qualified research has increased from 8% to 15%.

Provisions of the California Research Credit include:

• Taxpayers will receive 15% of the excess of current year research expenditures over a computed base amount (regular credit only)
• To receive a California Research Credit, a corporation must be allowed a research credit for the taxable year against federal income tax
• Taxpayers may carry over any unused amount to future years until none remains
• Controlled group members may assign credit to an affiliated corporation that is a member of the same group
• California does not conform to the Alternative Simplified Credit (ASC) but it does allow an election for the Alternative Incremental Research Credit (AIRC)
• The California Research Credit can be claimed using FB 3523

Meeting the Four-Part Test

In order for an activity or project to qualify for the research credit, the taxpayer must show that it meets all of the requirements in Internal Revenue Code § 41(d). Similar to the federal R&D credit, in order to claim the California Research Credit, the research activity must satisfy a four-part test:

• Section 174 Test: The research must have qualified as a business deduction
• Technological Information Test: The research must be undertaken to “discover information which is technological in nature”
• Business Component Test: The taxpayer must intend to use the information to develop a new or improved business component
• Process of Experimentation Test: The taxpayer must pursue a “process of experimentation” during substantially all of the research

Modifications from Federal R&D Law

There are several differences between California and federal law for claiming the research credit, so taxpayers must be familiar with the state requirements. Here are some of the things you need to know:

• There is no Alternative Simplified Credit (ASC) method in California
• Hospitals run by public universities and certain cancer centers are included in the definition of “qualified organization”
• “Qualified  research” and “basic research” must be conducted in California to qualify for the state credit
• The credit can be carried over indefinitely, but it cannot be carried back; it also has no termination date (federal credits can be carried back one year and forward 20 years)
• Research that has a specific commercial objective may qualify as basic “research”

Additional differences can be found here.

Find Out if Your Activities Qualify

The R&D tax credit can be a lucrative incentive for innovative businesses in California. Given the new permanent nature of the federal tax credit, now is the time to consider whether activities performed by your company qualify for major cash-saving tax credit opportunities.

Request a free assessment to determine qualifying R&D tax credit eligibility.

Tax Point Advisors, a firm with expertise in working with small and midsize companies, works with businesses that may qualify for R&D tax benefits. For more information, call us at 800-260-4138 or please leave us a message below.

Our Los Angeles office is managed by William Mehi who has helped dozens of clients claim millions of dollars in R&D tax credits. William resides in Massachusetts, and divides his time equally between our Boston, New York and Los Angeles offices.