California Research Tax Credit

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The California research and development (”R&D”) income and franchise tax credit is intended to reward taxpayers who increase research spending in California. The California research tax credit is comprised of three separate tax credits, namely the regular California research tax credit, the California alternative incremental research credit (AIRC), and the California credit for energy research (CFER). California taxpayers may claim the regular California tax credit or the AIRC in addition to the BRTC and CFER for California tax purposes.

Amount of the Regular California Research Credit

The regular California research tax credit is equal to fifteen percent of the difference between the taxpayer’s qualified research expenses (QREs) for activities in California in the current year over the taxpayer’s “base amount.” The base amount is equal to the taxpayer’s “fixed base percentage” plus the average annual gross receipts for the previous four tax years. The base amount cannot be less than fifty percent of the taxpayer’s QREs for the current tax year.

Research Tax Credit Fixed Base Percentage

The fixed-base percentage requirement makes it possible to determine if the taxpayer increased its research spending. There are two methods for determining the taxpayer’s fixed base percentage, namely, the historic and the start-up company methods. Taxpayers are to use the historic company method and not the start-up company method, unless they (1) were not operating or did not earn a profit in 1983, (2) were not operating or did not earn a profit for at least two tax years between 1983 and 1989, (3) were not incurring QREs in 1983, or (4) were not incurring QREs in at least two tax years between 1983 and 1989. Regardless of which method is used, the taxpayer’s fixed base percentage cannot exceed sixteen percent.

The historic company method for determining the taxpayer’s fixed base percentage is relatively straightforward. The fixed base percentage using the historic company method equals the total of the taxpayer’s QREs for tax years 1984 through 1988 divided by the taxpayer’s gross receipts for tax years 1984 through 1988.

The start-up company method for determining the taxpayer’s fixed base percentage is slightly more involved. The fixed base percentage using the start-up company method equals three percent for each of the five tax years in which the taxpayer has QREs. For tax years six through ten, the Code provides that the fixed base percentage for taxpayers using the start-up company method is a specific percentages identified in the Code multiplied by the total QREs for the taxpayer’s two prior years divided by the taxpayer’s gross receipts for the two prior years. The percentages identified in the Code are as follows: 1/6th for year six, 1/3d for the seventh year, 1/2 for the eight year, 2/3 in the ninth year, and 5/6 in the tenth year. For tax years after the tenth year, the Code provides that the fixed base percentage for taxpayers using the start-up company method is equal to the taxpayers total QREs for years five through ten divided by the taxpayer’s gross receipts for years five through ten.