Use the R&D tax credit to offset the S Corp. tax in California

Use the R&D tax credit to offset the S Corp. tax in California

Posted by Jeffrey Feingold on 10.27.21

It is always prudent and necessary to look for all possible tax deductions to offset the amounts of tax we pay. It is also extremely beneficial to find tax credits to apply. As a California S corporations that does research and development activities, you have some options available to you that can save thousands of dollars.

S Corp. taxes

California offers some differences in the S Corp. treatment that can be beneficial to the taxpayer. Although California taxes S corps at the entity level, a tax of 1.5% of net profits (minimum usually $800), the state's R&D credit can be used to partially offset this profits tax.  

S Corp. differences in California

Overall, the standard federal laws for computing California S corporation income apply. The differences for California state tax are:

  1. An S corporation's income is taxable at both the corporate level and the pass-through of its income to the shareholders is taxable on their returns.
  2. An S corporation is allowed tax credits and net operating losses.
  3. Taxes are computed differently on built-in gains and excess passive income.

R&D Tax Credits in California

California offers one of the best R&D tax credits of any state. This tax credit reduces income or franchise tax. This is not a deduction, but a bottom line, dollar for dollar tax credit against the tax owed. It currently is at 15% of the excess of your research expenditures during the current year minus a computed base amount. Unused amounts can be carried forward to future years until none is left. To qualify, your corporation must meet the four qualifications for the federal R&D tax credits as defined in Internal Revenue Code (IRC) §41. Wages, supplies, and contract research costs all apply when used for qualified research performed in the state of California. These credits can be claimed on the form 3523 for California R&D tax credit.

Differences between the Federal R&D Tax Credit and the California one

In California:

  • R&D tax credits cannot be carried back, but they can be carried forward indefinitely.
  • Gross receipts are calculated differently. Sales of real, tangible, and intangible property that are delivered or shipped to customers within the state, are included in the gross receipts calculation. Services income, rent, lease income, interest, and other non-property income sources are excluded from the calculation of gross receipts. This would include sales to the U.S. government, which could be identified as delivered in California.
  • The Alternative Simplified Credit is not available.
  • Gross receipts are defined differently.
  • There is no termination date for this credit.
  • The definition of "qualified organization" includes hospitals run by public universities and certain cancer centers.
  • Royalties and license payments are excluded from gross receipts for research credit purposes.

Tax Point Advisors recommend talking with a tax professional regarding these taxes credits for your company. Although the rules are extensive and sometimes confusing, it is well worth your time to consult a professional considering the amount of money that can be saved with this bottom line tax credit.

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