Orphan Drug Credit

The Orphan Drug Credit (ODC) is a crucial tax incentive provided under U.S. tax law to encourage pharmaceutical companies to develop treatments for rare diseases, often referred to as orphan diseases. These diseases affect a relatively small fraction of the population, usually defined as fewer than 200,000 individuals in the United States. The market for such drugs is limited, making it financially unattractive for companies to invest in research and development (R&D) without some form of government intervention. The Orphan Drug Credit is designed to offset the high costs associated with the development of these essential but otherwise unprofitable drugs.

Background

The Orphan Drug Act (ODA) was enacted in 1983 to provide financial incentives to encourage pharmaceutical and biotech companies to develop orphan drugs. The Orphan Drug Credit is a significant provision within this act. Initially, the ODC allowed companies to claim a tax credit for 50% of the qualified clinical testing expenses incurred during the development process of an orphan drug. However, changes brought about by the Tax Cuts and Jobs Act of 2017 reduced this credit to 25%.

Eligibility Criteria

To qualify for the Orphan Drug Credit, a drug must have received orphan designation from the Food and Drug Administration (FDA). The criteria for orphan designation include:

  1. Rarity of Condition: The drug should be intended for a disease affecting fewer than 200,000 people in the U.S., or
  2. No Hope of Financial Viability: If the condition affects more than 200,000 people, the sponsor must demonstrate that there is no reasonable expectation that the cost of developing and making available the drug in the United States will be recovered from sales.

Calculation of the Credit

The ODC is calculated as 25% of the qualified clinical testing expenses incurred for the tax year. Qualified expenses include costs related to:

  1. Clinical Trials: Costs related to conducting clinical trials, including payments to participating clinical sites, laboratories, and researchers.
  2. Manufacturing and Production: Expenses related to the production of the drug used in clinical trials.
  3. Regulatory Compliance: Costs associated with ensuring the drug meets all FDA regulatory requirements.

How to Claim the Credit

To claim the Orphan Drug Credit, companies must fill out IRS Form 8820, “Orphan Drug Credit,” and attach it to their annual tax return. The form requires detailed reporting of the qualified clinical testing expenses and any recapture amounts from previous years if applicable.

Interaction with Other Tax Provisions

The Orphan Drug Credit may interact with other tax provisions, including:

  1. Research and Development (R&D) Tax Credit: Companies cannot claim both the ODC and the R&D tax credit for the same expenses. They must choose which credit to apply to specific costs.
  2. Other Grants and Subsidies: Any government grants or subsidies received for drug development can affect the calculation of the ODC. Typically, such funding must be subtracted from the total qualified expenses.

Legislative Changes and Future Outlook

The Orphan Drug Credit has faced various legislative changes since its inception. The reduction from 50% to 25% qualified expenses under the Tax Cuts and Jobs Act of 2017 was significant and has been a subject of debate. Advocates argue that further reductions could stifle innovation in an area that desperately needs it.

There is ongoing legislative interest in either restoring the credit to its previous level or further reducing it, depending on the political and economic climate. Pharmaceutical companies and lobbyists continue to play a crucial role in shaping these policies.

Conclusion

The Orphan Drug Credit remains a vital tool in the U.S. healthcare landscape, encouraging the development of treatments for rare diseases. Despite legislative changes, it continues to offer significant financial incentives to pharmaceutical companies willing to invest in these critical but often financially nonviable areas of drug research and development.

For more information, you can visit the FDA’s Orphan Drug Designation page.