California ranks among the top states for R&D tax credit utilization — and for good reason. The state offers one of the most generous R&D credits in the country: a 15% credit on qualifying research expenses above a base amount, with no expiration date and unlimited carryforward. For businesses performing qualified research in California, this credit stacks on top of the federal credit under IRC §41, creating a combined benefit that significantly amplifies your tax savings.
But California’s credit isn’t just a copy of the federal one. The state has its own rules, its own calculation methods, and as of 2025, major changes under SB 711 that every California taxpayer needs to understand. If you claimed the old Alternative Incremental Credit (AIC) method, you need to act — that method was repealed effective January 1, 2025, and a previous AIC election will not automatically default to another credit (California Franchise Tax Board, 2025).
Here’s what you need to know about the California R&D credit, what changed in 2025, and how to maximize both your state and federal benefits.
Key Takeaways
- California’s R&D credit is 15% of qualifying expenses above a base amount under the Regular method, or 3% under the new ASC — and it stacks on top of the federal credit
- SB 711 (effective 2025) repealed the Alternative Incremental Credit and introduced the federal-style Alternative Simplified Credit — if you were on the AIC, you must elect a new method on your 2025 return or lose the credit entirely
- A temporary $5 million cap on combined business credits applies for tax years 2024-2026 — but unused credits carry forward indefinitely
- California already allows full R&D expensing — the state never adopted the TCJA’s 5-year amortization requirement, so there’s no Section 174 adjustment needed for California purposes
How Does the California R&D Credit Work?
The California Research Credit is codified under Revenue and Taxation Code §23609 (corporations) and §17052.12 (personal income tax). It’s modeled on the federal credit under IRC §41 but with California-specific rates and rules. The qualifying activities use the same four-part test as the federal credit — the only difference is that the research must be performed in California by employees or contractors physically located in the state.
There are now two calculation methods available:
Method 1
Regular Incremental Credit (RIM)
15% of California QREs exceeding the base amount (fixed-base percentage × average CA gross receipts for the prior 4 years). The base amount can’t be less than 50% of current-year QREs. Corporations can also claim a 24% basic research credit for payments to qualified universities and research organizations in California.
Method 2 (New for 2025)
Alternative Simplified Credit (ASC)
3% of California QREs exceeding 50% of the average QREs for the 3 preceding taxable years. If you have no QREs in any of the 3 preceding years, the credit equals 1.3% of current-year QREs. Simpler to compute, no fixed-base percentage needed.
What Changed Under SB 711 in 2025?
2025 Legislative Update
Governor Newsom signed Senate Bill 711 on October 1, 2025, making the most significant changes to California’s R&D credit in years. SB 711 updated California’s IRC conformity date from January 1, 2015 to January 1, 2025, and directly impacted how the research credit is calculated (BDO, 2025).
SB 711 Changes — Effective January 1, 2025
Alternative Incremental Credit repealed
The AIC method (1.49%, 1.98%, 2.48% tiered rates) is no longer available. If you previously elected the AIC, your election does not automatically default to another method. You must elect either the Regular credit or the new ASC on your timely-filed 2025 return, or you won’t receive any credit.
Alternative Simplified Credit introduced
California now conforms to the federal ASC under IRC §41(c)(4), with a 3% rate (vs. 14% federal). The ASC election is made on a timely-filed original return. Revoking it in a later year requires FTB consent per FTB Notice 2024-01.
IRC conformity updated to January 1, 2025
California now generally conforms to federal tax law as of January 1, 2025, with specific exceptions. However, California does not conform to the TCJA’s Section 174 amortization requirement — the state has always allowed full expensing of R&D costs.
Action required if you were on the AIC: This is the most urgent item from SB 711. The FTB has confirmed that a previous AIC election will not default to another credit method. If you don’t affirmatively elect the Regular credit or ASC on your 2025 return, you’ll get zero California R&D credit for the year — even if you have qualifying expenses. Don’t let this fall through the cracks.
How Do the State and Federal Credits Stack?
The California credit and the federal credit are separate calculations that apply to the same qualifying activities — but with important differences. You can claim both, and they stack, but there are a few things to watch.
The depreciation trap most businesses miss: California doesn’t conform to federal bonus depreciation. If you took 100% bonus depreciation on a cost segregation study at the federal level, you’ll need to add back the difference on your California return and depreciate those assets on California’s standard MACRS schedule. This creates two parallel depreciation schedules — one federal, one state — that need to be tracked separately. It’s not a reason to avoid the strategy, but it requires careful coordination.
The $5 Million Credit Cap: What It Means for You
For tax years 2024 through 2026, California imposes a temporary $5 million cap on the total combined business credits (including R&D) that can be applied to reduce your tax liability in any single year. This cap applies at the combined reporting group level for affiliated companies.
If your R&D credit exceeds the cap, the excess carries forward to future years. And there’s an additional option: under R&TC Sections 17039.4 and 23036.4, you can make an irrevocable election on Form FTB 3870 to convert disallowed credits into a refundable stream — effectively turning excess credits into cash over time.
For most small and mid-size businesses: The $5 million cap won’t be an issue — your combined business credits are unlikely to hit that threshold. But if you’re a larger manufacturer or tech company with significant R&D spending, cost segregation benefits, and other California credits, it’s worth modeling whether the cap limits your current-year benefit and whether the refundable election makes sense.
Which Method Should You Choose: Regular or ASC?
This is the most important tactical decision for California R&D credit planning in 2025, and the answer isn’t the same for every business.
Choose the Regular Credit when:
You have strong California gross receipts history, you can substantiate your fixed-base period data (this is the documentation that most frequently causes audit problems), and your QRE growth has been significant compared to your gross receipts growth. The 15% rate is much higher than the 3% ASC rate — if you can support the calculation, it’s usually more valuable.
Choose the ASC when:
You’re a startup or newer company without fixed-base period data. You’re a service company with zero California gross receipts (the FTB considers companies that only perform services — without product sales — to have zero CA gross receipts). You can’t substantiate decades-old historical data. The ASC’s 3-year lookback is dramatically simpler and reduces audit exposure.
From our practice: The introduction of the ASC is actually a bigger deal than most people realize. The FTB has identified fixed-base percentage substantiation as a primary cause of credit denial during audits. Companies that elected the Regular credit decades ago and can’t produce their 1984-1988 base period records have been losing credits on audit. The ASC eliminates that risk entirely — it only looks back three years. For many of our clients, switching to the ASC is the right move even though the rate is lower, because the credit they can actually defend is worth more than a higher credit that gets disallowed.
Every R&D Study We Perform Includes the State Credit
At Tax Formulations, we don’t treat the California credit as an afterthought. Every R&D study we perform for a California business includes the calculation of the state credit alongside the federal credit. We identify which employees and activities are physically located in California, allocate expenses between in-state and out-of-state where applicable, and compute the credit under whichever method — Regular or ASC — produces the best defensible result for your specific situation.
Our team is based in the Los Angeles area and works with businesses across Southern California and statewide. We understand the California-specific rules because we deal with them every day — from the gross receipts definition to the FTB’s examination procedures to the nuances of the new ASC election.
California Business? Let’s Stack Your Credits.
We’ll evaluate your qualifying activities, calculate both your federal and California credits, and help you choose the right state calculation method — all in one engagement.
Frequently Asked Questions
Can I claim both the federal and California R&D credits?
Yes. They’re completely separate credits that stack. The federal credit applies to all domestic U.S. research, while the California credit applies specifically to research performed in California. You file the federal credit on Form 6765 and the California credit on FTB Form 3523.
I was on the Alternative Incremental Credit — what do I do now?
SB 711 repealed the AIC effective January 1, 2025. Your previous election does not automatically transfer to another method. You must affirmatively elect either the Regular credit or the new ASC on your timely-filed 2025 return using FTB Form 3523. If you don’t elect, you’ll receive zero California R&D credit for the year.
Does California conform to the OBBBA’s Section 174A changes?
California’s conformity is nuanced. The state updated its IRC conformity date to January 1, 2025 under SB 711, but California never adopted the TCJA’s Section 174 amortization requirement in the first place — the state always allowed full R&D expensing. For the OBBBA’s Section 174A provisions specifically, check with your tax advisor on whether California has adopted them, as state-level conformity analysis can be complex.
What happens if my credit exceeds the $5 million cap?
Credits exceeding the $5 million annual cap carry forward indefinitely — they don’t expire. You also have the option to make an irrevocable election on FTB Form 3870 to convert disallowed credits into a refundable stream. The $5 million cap is temporary (2024-2026) and is expected to expire after the 2026 tax year.
Do I need to file separate R&D studies for federal and California?
No. A single R&D study can — and should — calculate both credits simultaneously. The qualifying activities are determined using the same four-part test; the difference is in the geographic allocation (California-only vs. all domestic) and the credit calculation method. At Tax Formulations, every study we perform includes both federal and applicable state credits. Read our complete R&D tax credit guide for federal credit details.
What Should You Do Next?
If your business performs qualified research activities in California, you should be claiming both the federal and state credits — and the SB 711 changes make 2025 a year that demands active attention. Whether you need to transition off the AIC, evaluate the new ASC method, or simply haven’t been claiming the California credit at all, now is the time to act.
Schedule a free consultation and we’ll review your California R&D credit position alongside your federal credit. We’re based in the LA area and work with California businesses every day — from software companies to manufacturers to aerospace and engineering firms.
Martin Gamez
Founder, Tax Formulations
Martin is a tax credit specialist with over 25 years of experience in federal and state R&D tax credits, cost segregation, and business tax incentives. Based in the Los Angeles area, his background includes tenure at Big Four and Top 10 accounting firms, with clients spanning technology, manufacturing, aerospace, engineering, and life sciences across California and nationwide. Read full bio →