Credits Against Tax
Included in the 2010 Patient Protection and Affordable Care Act, P.L. 111-148 (Patient Protection Act), are a few new income tax credits. In particular, there is one that many new startups and growing health care industry enterprises may benefit from—the qualifying therapeutic discovery project credit (Sec. 48D).
Prior to the passage of the Patient Protection Act, the only tax credits available for drug development or medical devices fell under either the research credit of Sec. 41 or the orphan drug credit of Sec. 45C. Congress has now increased the tax credits available to the health care industry through the addition of the qualifying therapeutic discovery project credit under Sec. 48D and the investment tax credit provisions of Sec. 46. This is designed to encourage investment in new therapies for diseases.
As of this writing, the new credit is still a work in progress. Congress appointed the IRS and the secretary of Health and Human Services to roll out a “certification procedure” for taxpayers that may qualify. The IRS established the certification procedures on May 21 (Notice 2010-45).
The credit is equal to 50% of the qualified investment for any qualified therapeutic discovery project of an eligible taxpayer. However, the IRS has announced that it will not certify more than $10 million as a qualified investment for any single taxpayer, meaning each taxpayer will be allocated no more than $5 million in credits or grants.
The following are the general criteria to qualify for the new credit provision under Sec. 48D.
Qualified Investment: Sec. 48D(b)
A qualified investment is the sum of the total costs paid or incurred in tax years beginning in 2009 and 2010 necessary for and directly related to the conduct of a qualifying therapeutic discovery project. There are specific costs that are not included in the qualified investment calculation. Excluded expenses include:
- Remuneration for the CEO of the taxpayer or any individual working in such a capacity;
- Interest expense;
- Facility maintenance expenses such as rent or mortgage payments, insurance, utility and maintenance costs, or wages for maintenance personnel;
- Service costs as defined by Regs. Sec. 1.263A-1(e)(4); and
- Any other cost the IRS determines as appropriate to carry out the purpose of the Sec. 48D tax credit.
The amount treated as a qualified investment with respect to any qualifying therapeutic discovery project cannot exceed the amount certified by the IRS as eligible for the credit (Notice 2010-45 §4).
In the case of certain costs that are paid for property of a character subject to an allowance for depreciation, the costs are treated as qualified investment when paid or incurred under the taxpayer’s method of accounting. There is no requirement that the property be placed in service in order to qualify for the tax credit.
The IRS has determined that if the taxpayer receives a grant that is excluded from income under Sec. 61, the amount of the qualified investment must be reduced by the amount of the grant (unless the grant can be used only for costs not included in the definition of a qualified investment) (Notice 2010-45 §4).
Qualified Therapeutic Discovery Project: Sec. 48D(c)(1)
A qualified therapeutic discovery project is a project designed to:
- Treat or prevent diseases or conditions by conducting preclinical activities, clinical trials, and clinical studies or carrying out research protocols for the purpose of securing approval of a product under the Food and Drug Administration or Section 351(a) of the Public Health Service Act;
- Diagnose diseases or conditions or determine molecular factors related to diseases or conditions by developing molecular diagnostics, molecular drugs, and companion drugs and diagnostics to guide therapeutic decisions; or
- Develop a product, process, or technology to further the delivery or administration of therapeutics.
Eligible Taxpayer: Sec. 48D(c)(2)
An eligible taxpayer is one who employs not more than 250 employees in all businesses of the taxpayer at the time of the submission of the application for certification. The aggregation rules under Secs. 52 and 414 apply.
Congress limited the amount of the available tax credits to $1 billion for the two-year period beginning in 2009. Taxpayers must submit an application including information the IRS may require for purposes of issuing certification for the tax credits. The IRS must approve or deny an application within 30 days of submission. In addition, the application can include a request for allocation of tax credits for both tax years beginning in 2009 and 2010.
The selection process has been codified (Sec. 48D(d)(3)). The IRS must consider only those projects that show reasonable potential to result in new therapies that treat areas of unmet medical need or to prevent, detect, or treat chronic or acute diseases and conditions, to reduce long-term health care costs in the United States, or to significantly advance the goal of curing cancer within the next 30 years. In addition, the IRS shall take into consideration which projects have the greatest potential to create and sustain high-paying jobs in the United States and to advance U.S. competitiveness in the fields of life, biological, and medical sciences. It should be interesting to see how the IRS makes these decisions. The IRS will publicly disclose the identity of the applicant and the amount of the credit allocated to the applicant.
The IRS has established a primary allocation round for certifying qualified investments made in tax years beginning in 2009 and 2010. If any of the available $1 billion remains unallocated after the primary allocation, additional allocation rounds may be conducted. The primary allocation round started when the application form was released and continued through July 21, 2010. The IRS’s preliminary review of timely filed applications will end on September 30, 2010. The 30-day clock for approval or denial of applications will then start on October 1, 2010.
Applications will be made on Form 8942, Application for Certification of Qualified Investments Eligible for Credits and Grants Under the Qualifying Therapeutic Discovery Project Program, which the IRS released on June 18, 2010. Notice 2010-45, Appendix A, describes the information that applicants will have to provide and provides questions that must be answered in a memorandum to be filed with the applicant’s Form 8942.
The devil is in the details: Taxpayers need to be aware of restrictions when they plan for utilization of this credit. The credit can be extremely helpful in enhancing cashflow for a taxpayer engaged in a project that involves clinical trials (which can be very costly); for that reason alone, it is important to plan for credit use.
The provisions deny any double benefit. For example, investments in property that qualifies for bonus depreciation under Sec. 168(k), New York Liberty Zone property, or Gulf Opportunity Zone property are not eligible investments.
In addition, taxpayers need to be aware that this new credit falls under the credit base restrictions of Sec. 49. Essentially, if a taxpayer’s investment in a qualified therapeutic project includes property of a character subject to depreciation and those costs are financed with nonrecourse debt that is not qualified commercial debt, the credit base must be reduced by the amount of nonrecourse financing.
The Sec. 48D credit is a component of the investment tax credit and the general business credit, so the rules and restrictions of Sec. 38 apply. Therefore, the credit is nonrefundable, it may not be used against alternative minimum tax, and limits apply to use against the regular income tax. Any unused credit in this particular case, for tax years beginning in 2009, can only be carried forward and not back because the effective date relates to expenditures for tax years beginning in 2009.
Grants in Lieu of Tax Credits
Section 9023(e) of the Patient Protection Act allows the IRS to pay nontaxable grants to taxpayers that qualify. Essentially, the same rules for the tax credit apply to the grant. Therefore, a taxpayer may receive a grant of up to 50% of the qualified investment in a qualified therapeutic discovery project.
For applications for grants for tax years beginning in 2009, the taxpayer will elect to apply for the grant under the application provisions of Sec. 48D(d)(2). For tax years beginning in 2010, the Patient Protection Act says that taxpayers shall not submit an application prior to the last day of the tax year and no later than the due date (including extensions) for that year’s tax return. However, the IRS has said that taxpayers can elect to treat a credit certification application as a grant application, and the IRS will treat a valid election to apply for a 2010 grant on Form 8942 as effective on the day after the last day of the taxpayer’s tax year.
The IRS will pay the amount of the grant during the 30-day period beginning on the later of the date of the application for the grant or the date the qualified investment is made. Special rules apply to the grant provisions for recapture of excessive grant amounts. Grants will not be awarded to nontaxpayers or any passthrough entities that have nontaxpayers who own equity or a profits interest in the taxpayer, so an LLC, a partnership, or an S corporation that has a Sec. 501(c)(3) organization as an owner will not qualify for the grant.
As stated, the tax credit can be very valuable. However, taxpayers should carefully plan up front to determine costs that qualify, structure financing of such projects to avoid reduction in the credit base, and analyze whether the tax credit or a nontaxable grant will provide a higher return on their investments in these projects in a shorter period of time.
Editor: Anthony S. Bakale, CPA, M. Tax.
Anthony Bakale is with Cohen & Company, Ltd., Baker Tilly International, Cleveland, OH.
For additional information about these items, contact Mr. Bakale at (216) 579-1040 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Baker Tilly International.