Are R&D Tax Credits Available in California?
Yes. The state of California provides the Research and Development (R&D) Tax Credit very similar to the federal version including the definition of qualifying research. Below are some of the differences between the federal and California R&D Tax Credits.
The credit is equal to the sum of the following:
- 15% of qualified expenses that exceed a base amount
- 24% of basic research payments
- The credit rate in California is 15% as opposed to 20% for federal purposes when using the regular calculation method
- There is no Alternative Simplified Credit (ASC) method in California
- Qualified Research must take place in California in order to qualify for the California credit
- California has adopted a permanent research and development tax credit
- Unused California research credits must be applied to the earliest tax year possible and then may be carried forward indefinitely, as opposed to federal credits which must be carried back one year and carried forward twenty
- S corporations may claim only 1/3 of the credit against the 1.5% entity-level tax (3.5% for financial S corporations) after applying the limitations relating to passive activity losses and credits.
- If a taxpayer with gross receipts cannot substantiate its base amount and/or fixed‐base percentage calculations for any reason, the taxpayer cannot simply claim that the "minimum base amount" (50% of current year qualified research expenses) applies in lieu of calculating the "fixed‐base percentage." Such a taxpayer is not entitled to credit for lack of substantiation.
California R&D Tax Credit Case Study
A San Francisco Company develops software used by its clients. It had never before claimed the R&D credit for the development activities of its software programmers. This project involved a four-year study with a three-year look back.
The Company qualified for the federal R&D Tax Credit of $330,000 and an additional $247,500 in California state R&D Tax Credit.
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FEDERAL
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CALIFORNIA
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Year
|
Total QREs
|
Credit
|
Total QREs
|
Credit
|
||
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2021
|
$1,300,000
|
$130,000
|
$1,300,000
|
$97,500
|
||
|
2020
|
$900,000
|
90,000
|
$900,000
|
$67,500
|
||
|
2019
|
$650,000
|
65,000
|
$650,000
|
$48,750
|
||
|
2018
|
$450,000
|
45,000
|
$450,000
|
$33,750
|
||
| Total | $3,300,000 | $330,000 | $3,300,000 | $247,500 | ||
Four-Part Test
Qualified research activities are defined by the four-part test outlined below
Technological in Nature
Activities must fundamentally rely on the principles of physical or biological science, engineering, or computer science.
Permitted Purpose
Activities must be performed in an attempt to improve the functionality, performance, reliability, or quality of a new or existing business component.
Eliminate Uncertainty
Activities intended to discover information that could eliminate technical uncertainty concerning the development or improvement of a product.
Experimentation
All activities must include a process of experimentation including testing, modeling, simulating, and systematic trial and error.