California recently modernized its tax code with the signing of Senate Bill 711 (“SB 711”), a significant milestone for research-driven businesses across the state. The legislation updates California’s research and development (“R&D”) tax credit to more closely align with federal requirements under Internal Revenue Code (“IRC”) Section 41, providing long-awaited relief for California taxpayers. SB 711 also affirms the state’s decoupling from the federal requirement to amortize foreign research expenses under IRC Section 174.
For tax years beginning on or after January 1, 2025, SB 711 restructures how businesses calculate the California R&D tax credit. While the California Regular Credit (“CRC”) method remains available, the bill introduces the Alternative Simplified Credit (“ASC”) method to replace the outdated Alternative Incremental Credit (“AIC”) method, providing California businesses with a modern calculation option that is free of historical base percentage limitations.
The AIC method was predicated on a tiered calculation approach relative to the taxpayer’s annual California apportioned sales (gross receipts). The applicable tax credit percentage ranged from 1.49% – 2.48% of current-year qualified research expenses (“QREs”). While the AIC was intended to be an alternative to the CRC’s rigorous substantiation requirements and to reward year-over-year increases in research spending, it often imposed significant base limitations, resulting in nominal credit amounts for taxpayers.
The new California ASC method is a true alternative to the CRC, offering a simpler calculation and a larger credit opportunity than the AIC. The California ASC method is calculated as 3.0% of current-year QREs exceeding a base amount (the base amount is calculated as 50% of the average annual QREs from the prior three tax years). If a taxpayer has no QREs in the prior three years, the California ASC calculation is modified to 1.3% of current-year QREs.
Similar to that of its predecessor, the new California ASC method is a permanent election that requires revocation approval by the California Franchise Tax Board (“FTB”). However, for tax year 2025, SB 711 grants taxpayers the option to elect their preferred calculation method on a timely filed original tax return.
SB 711 also permits taxpayers to carry forward unused California R&D tax credits indefinitely, up from the previous 15-year limit. This change ensures that valuable tax credits do not expire before they can be utilized.
In addition to modifying the state R&D tax credit, SB 711 also addresses the deductibility of research expenses. Under California and federal rules, domestic research expenses will be fully deductible in the year they are paid or incurred. However, SB 711’s decoupling from IRC Section 174 means taxpayers will have to amortize foreign research expenses over a 15-year period for federal income tax purposes but will receive a full deduction for such expenses in the year they are paid or incurred for California income tax purposes.
For research-intensive companies in California, SB 711 is a meaningful win. Historically, many California businesses were hampered by the CRC’s complex base substantiation requirements or were limited by high base percentage thresholds, often resulting in nominal credit amounts. For businesses that could not previously substantiate research activities dating back to the early 1980s, the low-yielding AIC method had been the only option.
SB 711 offers many businesses an opportunity to claim a material credit for the first time via the California ASC method. With improved access to the research credit, California businesses can more reliably plan for tax relief that supports continued innovation and technological advancement throughout the state.
SB 711 represents a structural shift in California’s R&D credit framework. The elimination of AIC and adoption of the California ASC method require proactive planning and recalibration of credit forecasting. Businesses leveraging California research credits should address these changes before finalizing their 2025 tax returns and establishing their 2026 estimated tax positions.
At Sagemont Group, we specialize in helping companies maximize their R&D tax credits while staying fully compliant with federal and state laws. We keep up with legislative changes like SB 711 so you can focus on innovation, ensuring you capture every credit opportunity available.
