California Research Credit - Overview
The California Research Credit reduces income or franchise tax. You qualify for the credit if you paid or incurred qualified research expenses while conducting qualified research in California. You receive 15 percent of the excess of current year research expenditures over a computed base amount. You may carry over any unused amount to future years until none remains. In addition, combined reporting group members may assign credit to an affiliated corporation that is a member of the same group. For more information, see FTB 3544A, List of Assigned Credit Received and/or Claimed by Assignee. You can also see Credit Assignment -- Revenue and Taxation Code Section 23663.
The research credit is claimed on FTB 3523.
Generally, California allows the credit in accordance with IRC § 41, as modified by California Revenue & Taxation Code §§ 17052.12 (Personal Income Tax) and 23609 (Corporation Tax).
Per California Revenue and Taxation Code §§ 17052.12 and 23609, 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). In order to claim the research credit, the research activity must satisfy a four-part test:
- The research must have qualified as a business deduction under IRC §174. [IRC §41(d)(1)(A)]
- The research must be undertaken to “discover information which is technological in nature.” [IRC §41(d)(1)(B)(i)]
- The taxpayer must intend to use the information to develop a new or improved business component. [IRC §41(d)(1)(B)(ii)]
- The taxpayer must pursue a “process of experimentation” during substantially all of the research. [IRC §41(d)(1)(C)]
There are several federal and state differences in the law; therefore, the taxpayer should be familiar with the California provisions for the year they are claiming the credit. Some of the California modifications to federal law are as follows:
- "Qualified research" and "basic research" must be conducted in California to qualify for the California credit.
- California does not conform to the federal "Alternative Simplified Method," but it allows an election for the "Alternative Incremental Research Credit."
- The definition of "qualified organization" includes hospitals run by public universities and certain cancer centers.
- Research that has a specific commercial objective may qualify as "basic research."
- For taxable years beginning on or after January 1, 2000, the credit is equal to 15% of the excess of the qualified research expenses, over the base amount, plus 24% of the basic research payments. Please see the chart on the California Research Credit page for prior year rates.
- The credit can be carried over indefinitely, but it cannot be carried back.
- The definition of "gross receipts" differs (see below).
- The credit has no termination date for California purposes.
A start-up company is a company that has either of the following:
- Fewer than 3 taxable years beginning after 1983 and before 1989 in which it has both gross receipts and qualified research expenses.
- For taxable years beginning on or after January 1, 1997, the first taxable year for which it has both gross receipts and qualified research expenses is a taxable year beginning on or after January 1, 1984. Prior to taxable years beginning on or before January 1, 1994, all "start-up companies" were assigned a fixed base percentage of 3% for both federal and California purposes. After January 1, 1994, the fixed base percentage of 3% only applies to the taxpayer's first 5 taxable years beginning after December 31, 1993, for which the taxpayer has qualified research expenses. For the taxpayer's 6th through 10th taxable years and all taxable years thereafter, see IRC § 41(c)(3)(B)(ii)(II)-(VII).
California gross receipts include receipts from the sale of real, tangible, or intangible property held for sale to customers in the ordinary course of the taxpayer's trade or business that is delivered or shipped to a purchaser within this state. This would include sales to the U.S. government, which could be identified as delivered in California. Excluded receipts would be items such as "throwback" sales, as well as receipts from services, rents, operating leases, and interest.
In addition, royalties and license payments would generally be excluded from the definition of gross receipts for research credit purposes. Transactions that operate as a combined sale of property and services would need to be evaluated on a case-by-case basis based on the terms of the contract. This California definition of gross receipts applies to both the average annual gross receipts for the prior four years and the base years (1984-1988).
A taxpayer with California qualified research expenses and zero California gross receipts can still claim the regular Incremental Research Credit. See Legal Division Guidance 2012-03-01.
For taxable years beginning on or after January 1, 1989, CR&TC § 23036 allows the research credit to reduce tax below the tentative minimum tax.