Strategic Analysis of the California R&D Tax Credit: Understanding the New 3% Alternative Simplified Credit (ASC) Rate (Post-SB 711)

Section I: Introduction: Defining the Alternative Simplified Credit (ASC)

The California Alternative Simplified Credit (ASC) Rate of 3% is the statutory percentage applied to the increase in current Qualified Research Expenses (QREs) over a simplified historical average. This percentage is used to calculate the non-refundable credit amount applied against state tax liability.1

1.1. The Mechanism of the 3% Credit Rate

The adoption of the ASC calculation method, enabled by Senate Bill 711 (SB 711), represents a significant modification to the California Research and Development (R&D) tax credit regime for tax years beginning on or after January 1, 2025.2

Under the ASC method, the California research credit is calculated as three percent ($3\%$) of the California Qualified Research Expenses (CA QREs) that exceed a specific base amount. This base amount is defined as fifty percent ($50\%$) of the average CA QREs incurred during the three preceding taxable years.1

The legislative intent behind introducing the ASC was to address a fundamental problem inherent in the long-standing Regular Method. The Regular Method often requires taxpayers to produce documentation relating to base years spanning back to 1984–1988 to substantiate their credit claims.1 Taxpayers frequently found it difficult, if not impossible, to locate these decades-old records, leading to complicated credit verification and prolonged audit resolutions, often resulting in the denial of the research credit.1

1.2. The Shift in Base Period Calculation Methodology

The ASC method provides a streamlined alternative by shifting the focus from historical gross receipts to recent qualified expenditures. The Traditional or Regular Method relies on calculating a Fixed-Base Percentage (FBP) derived from a taxpayer’s historical ratio of research expenses to gross receipts.4 This FBP is then multiplied by the average gross receipts of the preceding four years to establish the base amount.4

In stark contrast, the ASC method bypasses the Fixed-Base Percentage entirely. It is a QRE-centric calculation that uses a simple, rolling base period derived only from the three preceding tax years.1 This simplification is transformative because it alleviates the compliance burden associated with documenting business activity spanning more than three decades. The ability to substantiate the base amount using recent, manageable data—the three preceding tax years—as opposed to documents dating from over thirty years ago, is expected to significantly reduce documentation-related audit risks and improve the efficiency of tax compliance for both the taxpayer and the Franchise Tax Board (FTB).1

Section II: Legislative and Regulatory Milestones

2.1. Senate Bill 711: Modernizing State Conformity

Senate Bill 711 (SB 711), enacted on October 1, 2025, acts as the legislative vehicle for the adoption of the ASC method in California.3 As an urgency measure, the bill is effective immediately upon enactment and is generally operative for taxable years beginning on or after January 1, 2025.3

The adoption of the ASC calculation method is part of a broader conformity effort. SB 711 updates California’s specified conformity date to the Internal Revenue Code (IRC) from January 1, 2015, to January 1, 2025.3 The overall goal of this legislative action is to simplify the preparation of California income tax returns, the return-filing process, and the administration of California income tax laws.6

2.2. The Repeal of the Alternative Incremental Credit (AIRC)

The adoption of the ASC method coincided with the sunsetting of the Alternative Incremental Research Credit (AIRC), also known as the Alternative Incremental Method (AIM). SB 711 repeals the AIRC, making the method unavailable for election starting in tax years beginning after January 1, 2025.2

The elimination of the AIRC is significant because, despite being an alternative to the cumbersome Regular Method, the AIRC often resulted in a much smaller credit. Taxpayers previously relying on the AIRC were assigned a smaller, three-tiered fixed-base percentage and reduced credit rates (1.49%, 1.98%, and 2.48%).9 For many small and medium-sized companies, the resulting AIRC credit was often inconsequential compared to the potential benefit of the Regular Method or the newly available ASC.2

Taxpayers who previously elected the AIRC method face an immediate and critical compliance requirement. The FTB has indicated that a previous AIRC election will not default to another credit method (i.e., the Regular Method or the ASC).8 Consequently, taxpayers who were using the AIRC must proactively model their 2025 tax year credit under either the Regular Method or the new ASC. This election must be made on their timely-filed original return for the 2025 taxable year using FTB Form 3523.8 The consequence of failing to make this required election by the due date of the original return is the complete loss of the state R&D credit for that year.

2.3. Credit Utilization and Carryforward Enhancement

In addition to simplifying the calculation methodology, SB 711 enhanced the underlying value of the California R&D credit by removing prior statutory restrictions on credit carryforwards.2 Unused research credits may now be carried forward indefinitely until exhausted.2 This change substantially increases the intrinsic value of the credit, particularly for start-up and pre-profit companies that may generate large credits but lack sufficient taxable income to utilize them immediately. These credits can now be banked and applied against future state tax liabilities without the risk of expiration.

Section III: The 3% Rate Calculation Mechanics

The calculation of the 3% ASC credit is mechanical and dependent solely on the taxpayer’s Qualified Research Expenses (QREs) over a four-year window (the current year plus the three preceding years).1

3.1. Calculation Steps for the 3% ASC Rate

The calculation involves four distinct steps:

1. Calculate Average Prior QREs: The taxpayer identifies and calculates the average California QREs for the three prior tax years (P3Y).5
2. Determine ASC Base Amount: The average QREs from the P3Y are multiplied by $50\%$. This result defines the minimum expenditure level that must be exceeded in the current year to generate a credit.1
3. Calculate Excess QREs: The ASC Base Amount (Step 2) is subtracted from the Current Year QREs. The resulting difference is the incremental increase in research activities that qualifies for the credit.5
4. Compute Credit: The Excess QREs (Step 3) are multiplied by the statutory rate of 3%.1

3.2. Qualified Research Expenses (QRE) and California Modifications

The foundational definition of QREs for the California R&D credit generally conforms to the federal definition provided under IRC Section 41(b).9 However, California imposes crucial state-specific modifications that must be applied regardless of whether the ASC or Regular Method is used.

• Geographic Limitation: A core requirement is that all qualified research must have been conducted within California.9
• Contract Research Expenses (CRE): For amounts paid or incurred to non-employees for qualified research performed in California, only 65% of the expense is generally eligible for inclusion in QREs.4

• An exception exists for payments made to a qualified research consortium. In this specific scenario, 75% of the payments are treated as qualified research expenses.9 A qualified research consortium is defined as a tax-exempt organization described in IRC Section 501(c)(3) or Section 501(c)(6) that is primarily organized and operated to conduct scientific research and is not a private foundation.9

• Exclusion for Tangible Personal Property: California law dictates that QREs do not include any amounts paid or incurred for tangible personal property that is eligible for the exemption from sales or use tax under R&TC Section 6378.9

3.3. The Special Case: The 1.3% Start-Up Rate

The 3% ASC calculation requires a taxpayer to have incurred QREs in the three preceding years to establish the baseline.1

For taxpayers who are new to research activities or who do not have CA QREs for any one of the three preceding taxable years, a specialized, reduced rate applies. In this instance, the Alternative Simplified Credit rate is 1.3% of the current year CA QREs.1

This provision is critical for newly formed or rapidly scaling start-up firms. It is essential to note the significant disparity between the state and federal rates for new claimants: the California start-up ASC rate of 1.3% is substantially lower than the federal ASC start-up rate of 6%.3 This underscores the necessity of calculating the state and federal R&D credits independently.

Section IV: FTB Compliance and California-Specific Tax Policy

4.1. Local Revenue Office Guidance: The Election and Revocation

The California research credit, including the newly available ASC, is claimed by filing FTB Form 3523, Research Credit.10 The FTB made specific changes to Form 3523 for the 2025 taxable year to incorporate the ASC percentages and repeal the AIRC.7

The ASC method is an elective process. The election must be made on a timely-filed original tax return for the taxable year to which it applies.1 Once the election is made, it is binding and remains in effect until the taxpayer receives explicit consent from the Franchise Tax Board (FTB) to revoke the election.1 This requirement for FTB consent upon revocation compels taxpayers to conduct thorough initial modeling to ensure the ASC method is the optimal long-term strategy before committing to the election.

4.2. IRC Section 174 Non-Conformity: The Dual Strategic Advantage

Beyond the credit itself, California maintains a highly favorable tax policy regarding the treatment of Research and Experimental (R&E) expenditures that provides an additional financial benefit.

Federal tax law, specifically IRC Section 174 (as amended by the Tax Cuts and Jobs Act), now mandates that R&E expenditures be capitalized and amortized over five years (or fifteen years for foreign research).3 California has opted not to conform to these mandatory capitalization and amortization requirements. Instead, California retains the IRC Section 174 language as of January 1, 2015, which precedes these amendments.3

Consequently, for California tax purposes, all U.S. and non-U.S. R&E costs can still be immediately deducted (expensed).3 This policy offers California R&D firms a significant cash flow and tax timing advantage compared to federal requirements.

The combination of the research credit (an incentive reducing tax liability) and the immediate expensing of R&E costs (a benefit reducing taxable income) creates a powerful dual strategic advantage for businesses conducting research in the state. This favorable treatment underscores California’s commitment to maximizing investment in R&D activities within its borders.3

Section V: Case Study and Numerical Example (Applying the 3% Rate)

This example illustrates the practical application of the 3% California ASC rate for a company demonstrating sustained growth in Qualified Research Expenses.

5.1. Scenario: Advanced Research Solutions (ARS)

ARS is a California C-corporation analyzing its eligibility for the ASC credit for the 2026 tax year. The company’s California QREs for the past four years are detailed below.

5.2. Detailed Calculation Worksheet (ASC 3%)

The calculation uses the three preceding years (2023, 2024, and 2025) to establish the base amount for the 2026 credit.

Table: California R&D Alternative Simplified Credit Calculation (Tax Year 2026)

Based on this calculation, ARS generates a $\$39,000$ non-refundable California R&D tax credit for the 2026 tax year. This credit is applicable to the increase in QREs ($\$1.3$ million) above the calculated statutory base threshold ($\$500,000$).

Section VI: Strategic Analysis: ASC vs. CA Regular Method

The availability of the ASC method requires California taxpayers to conduct a rigorous analysis comparing the Regular Method and the ASC to determine which calculation provides the greatest benefit. This strategic decision involves balancing the lower 3% rate against the compliance relief offered by the ASC.

6.1. Comparative Credit Calculation Methods

6.2. Decision Metrics for Method Election

The choice between the 15% Regular Credit and the 3% ASC is fundamentally a trade-off between maximizing the credit rate and minimizing compliance risk and calculation complexity.

Factors Favoring the ASC (3%) Election:

1. Documentation Challenges: Taxpayers who lack the necessary historical records (1984–1988 data) required to substantiate the Fixed-Base Percentage calculation under the Regular Method should strongly consider the ASC. The ASC ensures that a credit can still be claimed, avoiding potential denial by the FTB due to insufficient documentation.1
2. High Fixed-Base Percentage (FBP): The Regular Method’s base calculation can be highly disadvantageous to mature companies that experienced high R&D intensity (high ratio of QREs to gross receipts) in the 1980s and 1990s. This history results in a high FBP, leading to a large base amount that current QREs cannot surpass, effectively yielding a zero credit under the Regular Method.2
3. Recent Growth: Companies experiencing significant and sustained growth in QREs over the past three years, particularly if that growth outpaces historical averages, will find the ASC advantageous, as it rewards current incremental increases based on a low, recent base amount.3

The 3% ASC provides a crucial strategic advantage for established California firms that were previously locked out of the R&D credit due to a high historical FBP. These taxpayers can now utilize the ASC to establish a new base amount based only on recent, lower QREs, generating a credit where none was available before.3

Conclusion: Maximizing the Credit in the Post-Conformity Era

The implementation of the 3% Alternative Simplified Credit via SB 711 fundamentally modernizes the landscape of the California R&D tax incentive. By addressing the severe compliance hurdles of the past, the ASC provides a reliable, data-centric method for calculating the state credit, opening up eligibility to a broader range of companies, including fast-growing entities and mature firms with problematic historical documentation.

For California businesses, the availability of the ASC mandates a thorough, side-by-side analysis comparing the benefits of the 15% Regular Credit against the 3% ASC. The strategic decision should prioritize not only the highest potential credit amount but also the ease of audit substantiation and the reduction of compliance risk.

The overall value proposition of conducting research in California is further strengthened by two key state policy decisions: the indefinite carryforward of unused R&D credits 2 and the continued ability to immediately deduct (expense) R&E costs under California’s non-conformity to IRC Section 174 capitalization rules.3

Taxpayers who elect the ASC method must be acutely aware that this choice requires filing the newly updated FTB Form 3523 on a timely original return. Furthermore, the decision is semi-permanent, as revocation of the ASC election requires specific consent from the Franchise Tax Board, underscoring the necessity of rigorous initial modeling and strategic commitment.1

R&D Tax Credit Preparation Services

Swanson Reed is one of the only companies in the United States to exclusively focus on R&D tax credit preparation. Swanson Reed provides state and federal R&D tax credit preparation and audit services to all 50 states.

If you have any questions or need further assistance, please call or email our CEO, Damian Smyth on (800) 986-4725.
Feel free to book a quick teleconference with one of our national R&D tax credit specialists at a time that is convenient for you.

R&D Tax Credit Audit Advisory Services

creditARMOR is a sophisticated R&D tax credit insurance and AI-driven risk management platform. It mitigates audit exposure by covering defense expenses, including CPA, tax attorney, and specialist consultant fees—delivering robust, compliant support for R&D credit claims. Click here for more information about R&D tax credit management and implementation.

Our Fees

Swanson Reed offers R&D tax credit preparation and audit services at our hourly rates of between $195 – $395 per hour. We are also able offer fixed fees and success fees in special circumstances. Learn more at https://www.swansonreed.com/about-us/research-tax-credit-consulting/our-fees/