The Question

“With all the changes, is California’s R&D credit still worth pursuing?”

This is the right question — and it’s one more companies should be asking.

California has long offered one of the most generous R&D credit regimes in the country. But generosity doesn’t automatically mean value. Between new limitations, refundability elections, and methodological changes effective in 2025, the credit now requires more intentional decision-making than it did in the past.

Some companies will still see meaningful benefit.
Others will spend time and money for very little return.

The difference comes down to how the credit fits into the broader tax picture, not whether it exists.

The Short Answer

California’s R&D credit can still be valuable in 2025 — but it is no longer a “default yes.”

The credit tends to make sense when:

• a meaningful portion of R&D is performed in California,

• the federal credit is already being claimed correctly,

• the company has sufficient tax liability or a clear strategy for carryforward or refundability,

• and the administrative effort is justified by the incremental benefit.

It tends not to make sense when:

• California payroll is minimal,

• expected credits are small relative to compliance effort,

• or the credit is pursued in isolation without a federal-first strategy.

What Actually Changed (and What Didn’t)

The Core Credit Is Still Strong

At its foundation, California’s R&D credit remains tied to the federal definition of qualified research.

For companies performing qualifying research in California, the regular credit is still calculated as:

• 15% of qualified research expenses above a base amount, and

• 24% of basic research payments.

That’s materially richer than many other states — and it’s why California remains relevant despite added complexity.

California Now Conforms to the Federal ASC (With Modifications)

Beginning January 1, 2025, California now conforms to the federal Alternative Simplified Credit (ASC) methodology — with important differences.

For California purposes:

• The ASC equals 3% of qualified research expenses above 50% of the average QREs from the prior three years.

• If the taxpayer has no QREs in any one of the prior three years, the credit is 1.3% of current-year QREs.

This change matters most for companies that:

• lack clean historical data,

• are newer,

• or previously struggled with base-period calculations.

However, the tradeoff is clear: the ASC is simpler, but the rate is significantly lower than the regular method.

Once elected, the ASC must be chosen on a timely filed original return, and revoking it later requires state consent. It is not something to choose casually.

The Alternative Incremental Credit Is Gone

As of 2025, California has repealed the Alternative Incremental Credit (AIC).

This simplifies the menu of options, but it also removes a method that some long-standing taxpayers relied on to optimize results. For most companies, the real choice is now between:

• the regular method (more complex, higher potential value), or

• the ASC (simpler, lower rate).

The $5 Million Credit Limitation Changes the Math

For tax years 2024 through 2026, California imposes a $5 million cap on the amount of business credits that can be used to reduce tax in a given year.

For companies that generate large credits, this limitation doesn’t eliminate value — it shifts timing.

Credits disallowed due to the cap can be:

• carried forward (with the carryover period extended), or

• converted into a refundable credit via an irrevocable election.

The refundable election allows taxpayers to recover 20% per year over five years, beginning in the third year after the election is made.

This is not immediate liquidity.
It’s delayed, structured recovery.

For some companies, that’s perfectly acceptable.
For others, it materially reduces the present value of the credit.

When the California Credit Is Still Worth It

California tends to make sense when:

• the company already claims the federal credit correctly,

• California represents a meaningful share of engineering payroll,

• credits are large enough to absorb the added compliance cost,

• and the company has either current tax liability or a long-term planning horizon.

It’s especially relevant for companies building long-lived tax attributes — whether for future profitability or eventual acquisition. Well-documented California credits can enhance the quality of those attributes, not just their size.

When It Often Isn’t

The credit frequently disappoints when:

• only a small fraction of R&D occurs in California,

• expected credits are modest,

• refundability timing is misunderstood,

• or the credit is pursued reactively rather than strategically.

In those cases, the incremental value of the California credit may not justify the administrative drag — even though the underlying rate looks attractive on paper.

The Bigger Picture: California Should Not Be Viewed in Isolation

The most common mistake companies make is evaluating California on its own.

California only makes sense when it fits into a federal-first, system-based approach. The federal credit sets the foundation. California either meaningfully layers on top — or it doesn’t.

When companies evaluate California as part of a broader strategy, decisions become clearer and outcomes improve.

The Takeaway

California’s R&D credit is still powerful — but it’s no longer automatic.

The 2025 changes reward companies that:

• understand their facts,

• choose methodologies intentionally,

• and evaluate value over time, not just on a single return.

For the right company, California can still be a meaningful contributor.
For others, the smartest move may be to simplify, defer, or focus elsewhere.

The key is not chasing the credit — it’s knowing when it actually earns its place in the strategy.