Expert Analysis of the California Research and Development Tax Credit: The Election to Assign Credit (R&TC § 23663)

I. Executive Summary: The Strategic Function of the Election to Assign Credit

The Election to Assign Credit is an irrevocable statutory mechanism under California Revenue and Taxation Code (R&TC) Section 23663 allowing a C Corporation (Assignor) within a combined reporting group to transfer all or part of its California R&D tax credit to another affiliated C Corporation (Assignee) within the same group. This election facilitates the immediate utilization of valuable, non-refundable research credits that might otherwise be carried forward indefinitely by the generating entity due to insufficient current-year tax liability.1

The primary strategic rationale for the assignment mechanism is the maximization of the timely realization of tax benefits across a multi-entity corporate structure. While the California Research Credit (R&D Credit) offers generous terms, including indefinite carryforward of unused amounts 2, its nature as a non-refundable credit 3 means corporations that generate substantial credits but have minimal current tax liability (e.g., development-stage companies or those incurring net operating losses) cannot immediately monetize the incentive.1 R&TC Section 23663 resolves this structural issue by allowing the legal transfer of the credit asset to a profitable affiliate that possesses sufficient “net tax” liability to utilize the credit immediately.4

The fiscal importance of this mechanism is significant given the scale of California’s R&D credit program. The R&D credit is, by far, the state’s largest business tax credit, costing California over $2.5 billion in 2023.5 Preliminary data indicates that major corporations maintain massive stockpiles of these credits; for instance, Alphabet and Apple have reported holding California R&D credits totaling $6.4 billion and $3.5 billion, respectively, available to offset future state tax liabilities.5 Consequently, R&TC 23663 is an essential component for managing this vast pool of deferred corporate tax assets, enabling strategic utilization by members of a combined reporting group.

II. Foundation of the California Research and Development Tax Credit

2.1. Calculation Methods and Scope (R&TC § 17052.12)

The California R&D tax credit is authorized under R&TC Section 17052.12 (for personal income tax purposes) and Section 23609 (for corporation tax purposes) and reduces income or franchise taxes.1 The calculation closely mirrors the federal Internal Revenue Code (IRC) Section 41 credit.2

Under the Regular Credit Method, the amount allowed is the sum of:

1. Incremental Research Expenses: 15% of the excess of current-year qualified research expenditures (QREs) over a computed base amount.1 The base amount is calculated by applying a fixed-base percentage to the average annual gross receipts for the four preceding years.2
2. Basic Research Payments: 24% of the basic research expenses for the taxable year.2

California utilizes the federal definition for Qualified Research Expenses (QREs), which includes in-house research expenses (such as taxable wages for employees performing qualified services, supplies, and computer rental costs) and contract research expenses.6 Contract research expenses generally qualify at 65%, although research performed by a qualified research consortium can be claimed at 75%.6

Taxpayers conducting research may also elect the Alternative Incremental Credit (AIC) method.2 This method is designed for businesses with fluctuating QREs and allows the credit to be calculated in tiered percentages based on QREs as a percentage of gross receipts.2 The election to use the AIC method is irrevocable and applies to all subsequent taxable years unless revoked with approval from the Franchise Tax Board (FTB).2

A critical difference between the California and federal credits is the state nexus rule: only QREs incurred within California are eligible for the state credit.2

2.2. Unused Credit Management

The R&D credit is classified as a non-refundable credit.3 It cannot reduce certain taxes, including the minimum franchise tax, the annual tax for pass-through entities (PTEs), or the Alternative Minimum Tax (AMT).3

If the available credit amount exceeds the current-year tax liability, the unused portion is not lost but rather may be carried over to succeeding taxable years until it is fully exhausted.1 Unlike previous federal rules, California allows for an indefinite carryforward period.2 Credits cannot be carried back to prior tax years.3

The indefinite carryforward provision, combined with the corporate assignment mechanism established by R&TC 23663, allows multi-state C Corporations to accumulate and manage billions of dollars in unused credits as long-term assets.5 This credit pool functions as a deferred corporate tax asset, which is fully realized only when utilized against positive tax liability, a process often requiring the assignment mechanism to transfer the asset to a profitable group member. This structure positions the credit as a strategic liquidity tool, rather than merely a defensive loss-prevention measure against a statutory expiration date.

III. The Election to Assign Credit (R&TC § 23663): Statutory and Regulatory Analysis

The general assignment statute for eligible credits, R&TC Section 23663, permits C Corporations filing a combined report to transfer tax credits among affiliated corporations within the combined reporting group.8 This mechanism is distinct from the allocation rules governing credits distributed by pass-through entities (PTEs) to their partners or shareholders.8

3.1. Defining Eligibility for Assignment

For an R&D credit assignment to be valid, strict criteria must be met regarding the roles of the assignor and assignee:

• Assignor and Assignee Status: Both the assignor (the entity generating the credit) and the assignee (the entity receiving and utilizing the credit) must be affiliated C Corporations that are members of the same combined reporting group.8
• Specificity of Assignee: The assignor must assign the credit to a specific affiliated corporation.8 Assignment cannot be made to a “division,” a line of business, or a group of corporations defined generically within the entire combined reporting group.8
• Disregarded Entity Exclusion: A single owner eligible business entity, such as a Single Member Limited Liability Company (SMLLC) that is disregarded as an entity separate from its owner, is treated as a division of the parent company.8 Since assignments cannot be made to divisions, a disregarded entity is not an eligible assignee under R&TC 23663.8

3.2. Critical Date Requirements for Eligibility (The Dual-Date Test)

FTB guidance mandates that eligibility for assignment is proven by demonstrating that the assignor and assignee were part of the same combined reporting group on two specific dates.8 The applicable dates depend on the taxable year in which the credit was initially generated:

1. Credits Generated Before July 1, 2008: The assignor and assignee must have been members of the same combined reporting group on both:

• June 30, 2008.8
• The last day of the taxable year of the assigning taxpayer in which the eligible credit is assigned.8

1. Credits Generated On or After July 1, 2008: The assignor and assignee must have been members of the same combined reporting group on both:

• The last day of the taxable year in which the credit was first allowed to the assignor.8
• The last day of the taxable year of the assigning taxpayer in which the eligible credit is assigned.8

The historical requirement that entities must be affiliated as of the fixed date of June 30, 2008, for credits generated prior to that cutoff, presents a significant compliance challenge for corporations managing long-term credit carryovers. Given the indefinite carryforward allowance for R&D credits 2, corporations relying on pre-2008 credits must maintain irrefutable evidence of corporate structure and affiliation dating back over a decade and a half. This requirement introduces substantial historical record-keeping and corporate governance verification burdens, which are critical risk points during FTB audits and must be a focus of due diligence in corporate mergers and acquisitions involving large credit pools. The validity of the assignment rests not only on the generation of the credit but also on the continuity of the affiliation dating back to the specified periods.

Table 1 summarizes the specific affiliation dating requirements for the R&D credit assignment:

Table 1: Combined Reporting Group Eligibility Dates for R&D Credit Assignment (R&TC § 23663)

3.3. Consequences of the Election: Irrevocability and Limitations Transfer

Once the election to assign credit is made, several statutory consequences apply:

• Irrevocability: The assignment election is absolute and irrevocable.8 The credit cannot be subsequently reassigned from the original assignee to a third party.8
• Assignor Forfeiture: The amount of credit assigned becomes permanently unavailable for application against the assignor’s tax liability in the same taxable year.11 This holds true even if the assignor later receives a notice of proposed assessment that increases its tax liability for the year the credit was generated or assigned.11 This statutory control ensures that assigned credits cannot be simultaneously used for offensive purposes (monetization via assignment) and defensive purposes (offsetting a later audit deficiency) by the assignor, thereby simplifying the audit trail and placing the responsibility for the assigned credit solely on the assignee.
• Limitations Transfer: The carryover period and any statutory limitations or restrictions that applied to the assignor carry through and apply directly to the assignee.8 However, the FTB clarifies that the assignee does not need to be engaged in a qualified research activity to receive or utilize the R&D credit.12

IV. FTB Compliance Procedures: Form FTB 3544 Implementation

The administration of the Election to Assign Credit requires the filing of California Form FTB 3544, Assignment of Credit.10 This form establishes the necessary symmetry and transparency required for the FTB to track the transfer of the credit asset between the related parties.

4.1. Assignor Filing Requirements (FTB 3544, Part A)

The assignor—the corporation making the assignment—must complete the top portion of Form FTB 3544 and specifically complete Part A, Side 1.10 Part A is used exclusively when the corporation is making the election to assign the credit and serves as the irrevocable statutory election document.10

The assignor must adhere to specific detailed listing requirements 13:

• The assignor must separately list credits that were generated in different taxable years (“vintage”).13
• The assignor must disclose, in an attached statement, any separate and distinct limitations applicable to each of those vintage credits.13

The requirement to list credits by vintage ensures that the FTB can trace the transferred amount back to its generation year, which is crucial because the generation year dictates which of the Dual-Date Tests (Table 1) must be met for the assignment to be deemed valid under audit.8 This detailed tracking requirement is integral to mitigating compliance risk.

4.2. Assignee Reporting Requirements (FTB 3544, Part B)

The assignee—the affiliated corporation receiving the credit—does not complete Part A. Instead, it completes Part B, Side 2 of Form FTB 3544 to report the receipt and utilization of the credit.13

Part B tracks the flow of the assigned credit, including:

• Assigned credit amount received in the current taxable year.13
• Assigned credit carryover from prior taxable years.13
• Assigned credit amount claimed in the current taxable year.13
• Assigned credit amount carried over to future taxable years.13

Both the assignor and the assignee must jointly complete the top portion of Form FTB 3544, identifying the “Key corporation” name, California key corporation number, and the specific credit name and code.10 This joint identification ensures required symmetry between the transferring and receiving parties, allowing the FTB to cross-verify the transferred amount and ensuring that discrepancies—a common audit trigger—are minimized.

V. Utilization Constraints and Recent Legislative Changes (2024-2026)

The strategic flexibility afforded by R&TC 23663 is temporarily constrained by recent legislation establishing a fixed annual cap on credit utilization, which significantly impacts corporate groups holding large R&D credit pools.

5.1. Group-Level Application of the $5,000,000 Credit Limitation (R&TC § 23036.4)

For taxable years beginning on or after January 1, 2024, and before January 1, 2027, the application of all business credits (including the R&D credit and its carryovers) is subject to a $5,000,000 limitation.13 The total of all credits may not reduce the “tax” for corporate filers by more than $5,000,000.14

Crucially, for taxpayers included in a combined report, this $5,000,000 limitation is applied at the combined group level.13 This rule prevents the combined group from utilizing more than $5 million in total credits annually, regardless of the number of credits generated or assigned internally.

For large corporate groups with billions in credit stockpiles 5, this temporary cap severely restricts the economic benefit derived from the assignment mechanism. While R&TC 23663 allows for the perfect transfer of credits to the most profitable entity, the functional benefit of that transfer is limited to a maximum $5 million offset during this three-year window. This shift transforms the assignment decision from one of maximizing immediate tax offset to one of determining which entity within the group should claim the highly limited $5 million allowance. Any assigned credits exceeding the $5 million group threshold are effectively pushed back into carryover status, unless the refundable election is made.

5.2. The Irrevocable Refundable Election (FTB 3870)

If a taxpayer’s R&D credit utilization is restricted by the $5,000,000 cap, R&TC Section 23036.5 permits an irrevocable election to convert the disallowed credits into a refundable credit stream.13

The key mechanics of this election are as follows:

1. Mandatory Scope: The taxpayer must make the election for all qualified credits disallowed due to the $5 million limitation; a partial election is not permitted.13
2. Election Timing: The irrevocable election must be made annually by completing Form FTB 3870, Election for Refundable Credit, and submitting it with an original, timely filed tax return.13 S corporations are prohibited from electing refundability for credits taken at the entity level.13
3. Payout Structure: The “credit amount” (the portion disallowed by the cap) is paid out in five equal annual installments, representing 20% of the total disallowed credit in each year of the refundable period.13
4. Delayed Commencement: The five-year refundable period begins the third taxable year after the taxable year in which the election is made.13 For instance, an election made with a 2024 return results in the first 20% refundable payment being claimed in the 2027 tax year.

The significant three-year deferral before the five-year payout commences creates a substantial erosion of the present value of the disallowed credit pool.15 For corporate tax management, the decision to elect refundability via FTB 3870 versus opting for the default indefinite carryover requires precise financial modeling. This timing structure suggests that the legislature intended to mitigate immediate cash outflow consequences of this relief, making the election most beneficial for groups prioritizing long-term certainty of recovery over immediate liquidity. If the election is not made, the disallowed credits default to carryover status, and the carryover period is extended by the number of years the credit was disallowed.13

VI. Detailed Compliance Case Study: Assignment for Immediate Benefit

This illustration demonstrates the operational necessity and mechanical flow of the R&D credit assignment under R&TC 23663 and the required FTB compliance reporting using Form FTB 3544.

6.1. Scenario Setup: Research Credit Generation and Combined Group Tax Liability (2024 Tax Year)

Consider a combined reporting group consisting of two C Corporations:

Innovator Corp (A) generates a substantial R&D credit through its California-based QREs but, due to current losses or a startup phase, pays only the statutory minimum franchise tax.3 Sales Corp (B) is highly profitable and has significant tax liability. Both corporations meet the required affiliation dates for the 2024 credit vintage.8

6.2. Steps for Execution and Compliance

1. Assignor Utilization Constraint: Innovator Corp (A) cannot utilize its $1,000,000 R&D credit to reduce its minimum franchise tax of $800.3 The credit would be carried forward indefinitely unless assigned.
2. Assignment Decision: To realize the tax benefit immediately, the combined group determines that Innovator Corp (A) must assign the credit to Sales Corp (B).
3. Assignment Election (Corp A): Innovator Corp (A) files its tax return, attaching FTB 3544, Side 1, Part A. It irrevocably elects to assign $1,000,000 of the 2024 R&D credit to Sales Corp (B).10 Innovator Corp (A) must internally document that the assigned $1,000,000 is unavailable to offset any subsequent audit assessment.11
4. Assignee Claim (Corp B): Sales Corp (B) files its return, attaching FTB 3544, Side 2, Part B. It reports the receipt of the $1,000,000 assigned credit.13
5. Credit Application: Sales Corp (B) applies the entire $1,000,000 assigned credit against its $2,000,000 tax liability. The final tax liability for Sales Corp (B) is reduced to $1,000,000 ($2,000,000 – $1,000,000).
6. Combined Group Limitation Check: The group utilized $1,000,000 in credits, which is well below the temporary $5,000,000 group limitation effective for the 2024 taxable year.13

Table 3: Hypothetical R&D Credit Assignment Transaction (FTB 3544 Summary)

This case demonstrates that the assignment achieves an immediate $1,000,000 reduction in the combined group’s tax burden, thereby maximizing the liquidity and utility of the R&D incentive. Without R&TC 23663, this asset would have been effectively frozen on Innovator Corp (A)’s balance sheet for the foreseeable future.

VII. Conclusions and Corporate Compliance Mandates

The California Election to Assign Credit under R&TC Section 23663 is a vital component of state tax planning for combined reporting groups. It transforms the non-refundable R&D credit from a deferred asset into an immediate tax offset, contingent on strict statutory and regulatory adherence.

Corporate tax compliance mandates resulting from this analysis include:

1. Verification of Affiliation Dates: Corporate tax directors must maintain meticulous documentation supporting the requisite “dual-date” affiliation test for every vintage of R&D credit assigned, particularly credits generated before July 1, 2008, which require proof of affiliation dating back to June 30, 2008. Failure here voids the assignment, leading to assignee tax deficiencies.
2. Irrevocability and Audit Risk: The irrevocable nature of the assignment necessitates careful internal modeling to ensure sufficient credit is retained by the assignor to cover potential future audit adjustments before executing the FTB 3544 election.
3. Group Limitation Planning (2024–2026): For the 2024 through 2026 taxable years, strategic planning must account for the temporary $5,000,000 group-level limitation. Tax executives must model the trade-off between the indefinite carryover of disallowed credits and the election of the delayed, refundable credit stream via FTB 3870, recognizing the significant present value erosion caused by the three-year commencement delay.

Accurate Form 3544 Reporting: Strict symmetry is required between the assignor’s reporting (Part A, relinquishment) and the assignee’s reporting (Part B, claim). The mandatory listing of credits by generation year is critical for audit traceability against the specific historical eligibility requirements.

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/