Introduction
Startups across the U.S. leverage the federal payroll R&D credit to offset up to $500,000 in employer-side payroll taxes. But what about California?
In 2025, California still does not allow R&D credits to offset payroll tax, and its overall research credit program is non-refundable and capped for corporations.
This guide explains why CA R&D credit remains limited, how startups can still benefit, and what you need to know about applying these credits.
IRS and California Tax Code References
- IRC §41(h) – Payroll tax credit for qualified small businesses
- Cal. R&TC §23609 – California Research Credit rules
- FTB Publication 1082 – CA Research Credit guidance
- IRS Form 8974 – Federal payroll tax offset form
Why California’s R&D Credit Is Capped
Unlike the federal R&D credit:
- California’s credit is non-refundable
- It can only be used to offset income or franchise tax
- The state does not allow offsetting payroll tax liabilities
Cap Reason: California’s tax structure doesn’t include a refundable mechanism like IRS Form 8974, making it less startup-friendly.
Example: Robotics Startup with No Net Income
Example: MotionAI Inc., a robotics company in Oakland, spends $350,000 on qualified R&D wages in 2025.
- Federal credit: ~$40,000, claimed via Form 6765
- Federal payroll offset: $40,000 applied to Form 941 via Form 8974
- California credit: ~$50,000 but unused because MotionAI has no taxable income in CA
That $50,000 carries forward, but offers no short-term relief.
Step-by-Step: Maximizing CA R&D Credit Despite the Cap
- Claim Federal Payroll Credit via Form 8974
If eligible, use Form 8974 to offset federal payroll taxes immediately. - File CA Form 3523 Annually
Even if not used, claiming it ensures you build up credit carryforward. - Consider Entity Structure
S-Corps may benefit more from credit offsets than sole proprietors in CA. - Track Credit Carryforwards
CA credits carry forward indefinitely track properly in your books. - Revisit Once Profitable
Once your company generates income, you can use the accumulated credit to reduce CA franchise tax.
Conclusion
California’s R&D credit program is capped by design no payroll offsets, no refunds.
Still, founders should file and accumulate the credit to use once profitable. Combine this with the federal payroll offset for real-time benefit.
Call to Action
Not sure how to claim the R&D payroll credit or structure CA carryforwards?
Schedule a credit strategy session with Anshul Goyal, CPA, EA, FCA
Anshul helps startups:
- Leverage federal payroll offsets
- Track and apply CA credit carryforwards
- Understand multi-entity optimization for credit use
Capture every credit you’re entitled to:
https://calendly.com/anshulcpa/
Anshul Goyal, CPA, EA, FCA
Anshul brings 15+ years of U.S. and international tax experience. He specializes in helping online sellers, foreign founders, and U.S. residents with IRS and multi-state compliance. Known for his deep knowledge in Shopify and Amazon seller tax strategy, Anshul has helped hundreds of entrepreneurs minimize taxes and scale legally.
Disclaimer
This blog is for informational purposes only and does not constitute legal or tax advice. Please consult a qualified tax professional regarding your individual tax situation.
Top 5 High-Searched FAQs for 2025
1. Does California offer a refundable R&D credit?
No. It is non-refundable and cannot offset payroll tax.
2. Can I use CA R&D credit if my business has no income?
No. The credit carries forward until you have income.
3. Is the federal R&D credit refundable?
Partially. Startups can apply it to offset up to $500,000 in payroll taxes.
4. How long can I carry forward California R&D credit?
Indefinitely. There is no expiration.
5. What form do I use to claim CA R&D credit?
Use Form 3523 attached to your CA business tax return.