5/18/13 Research Credit - Overview | California Franchise Tax Board

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Research Credit - OverviewDisclaimer

Research Credit - Overview

IRC § 41 provides for a federal research tax credit equal to 20% of the amount by which a taxpayer's qualified researchexpenditures for a taxable year exceeded its base amount for that year, or for basic research payments. California allows acredit against tax for the amounts paid or incurred for research conducted in California. Generally, California allows the credit inaccordance with IRC § 41, as modified by California Revenue & Taxation Code §§ 17052.12 (Personal Income Tax) and 23609(Corporation Tax). There are several other federal and state differences, as well as several law changes that are effective for1993 and after. Therefore, the auditor should be familiar with the California provisions for the year under audit. It should be notedthat a taxpayer could make a federal election for the first taxable year beginning after June 30, 1996 and before July 1, 1997(also available for later years), to use an alternative method for computing the credit called the Alternative Incremental Credit.California incorporates this provision, for taxable years beginning on or after January 1, 1997. (with a change to the rates as ofJanuary 1, 1998). Once the election is made it applies to all succeeding taxable years unless revoked with the consent of theFranchise Tax Board. The alternative incremental credit is an alternative method to the original (or "regular") method forcomputing the credit; the election to apply the alternative incremental method only effects the calculation of the credit for qualifiedresearch expenses and does not apply to the calculation of the credit for basic research payments.

California law currently conforms, with specific modifications, to the federal research credit as it existed on January 1, 2001.The more common modifications are:

The definition of "Qualified Organization" includes hospitals run by public universities and certain cancer centers.

"Basic Research" and "Qualified Research" must be conducted in California to qualify for the California credit.

Research that has a specific commercial objective may qualify as "basic research".

California only allows corporations to claim the credit for basic research payments.

California conforms to the special rules of IRC section 41(f) for aggregation of expenditures for members of a controlledgroup of corporations, allocation of expenditures, adjustments for certain acquisitions, dispositions and adjustments forcertain reimbursements that must be taken into account in determining fixed-base percentage as well as special rules forshort taxable years. Note that combined reporting principles do not apply to the computation of the California researchcredit. The credit cannot be allocated or otherwise transferred to another taxpayer, even if the other taxpayer is a memberof a unitary or combined group or otherwise affiliated with the taxpayer that earned the credit. For example, a subsidiarycorporation that generates a research credit cannot allocate the credit to the parent corporation or to other subsidiaries inthe combined return.

The California credit percentages have changed several times over the years. For taxable years beginning on or afterJanuary 1, 2000, the credit is equal to 15% of the excess of the qualified research expenses, over the base amount, plus24% of the basic research payments. Please see the chart at: R&D Credit References for prior years' rates.

The credit cannot be carried back.

The definition or "gross receipts" differs.

The termination dates provided for under federal law do not apply (IRC § 41 does not apply to any amount paid or incurredafter June 30, 1995, and before July 1, 1996, or after June 30, 2004). Currently, there is no California termination date forthis credit.

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 qualifiedresearch expenses; or

For taxable years beginning on or after January 1, 1997, the first taxable year for which it has both gross receipts andqualified research expenses is a taxable year beginning on or after January 1, 1984. Prior to taxable years beginning on orbefore January 1, 1994, all "start-up companies" were assigned a fixed base percentage of 3% for both federal andCalifornia purposes. After January 1, 1994, the fixed base percentage of 3% only applies to the taxpayer's first 5 taxableyears beginning after December 31, 1993, for which the taxpayer has qualified research expenses. For the taxpayer's 6ththrough 10th such 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 theordinary course of the taxpayer's trade or business that is delivered or shipped to a purchaser within this state. This wouldinclude sales to the U.S. government, which could be identified as delivered in California. Excluded receipts would be items suchas "throwback" sales, as well as receipts from services, rents, operating leases and interest. In addition, royalties and licensepayments would generally be excluded from the definition of gross receipts for research credit purposes. Transactions thatoperate as a combined sale of property and services would need to be evaluated on a case-by-case basis based on the terms ofthe contract. This California definition of gross receipts applies to both the average annual gross receipts for the prior four yearsand the base years (1984-1988).

5/18/13 Research Credit - Overview | California Franchise Tax Board

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For taxable years beginning on or after January 1, 1989, CR&TC § 23036 allows the research credit to reduce tax below thetentative minimum tax.

The Research and Development Credit must be claimed on the form FTB 3523.