The GOP tax bill, known formally as the "Tax Cuts and Jobs Act" (H.R. 1), was signed into law by President Trump on December 22, 2017, in what is considered to be the first major overhaul of the federal tax code in more than three decades. The tax bill dramatically changed the corporate tax law and could have a particular impact on life sciences companies both abroad and in the U.S. Below are some observations of a few potential ways that the new tax bill will impact life sciences companies positioned solely within the U.S.
Reduced corporate tax rate
Probably at the center of the tax bill is a reduction of the overall corporate tax rate. The final version of the tax bill reflects a 21% corporate tax rate that will be effective January 1, 2018, an increase from the 20% rate in the bills passed by the House and the Senate, but less than the 35% tax rate previously in effect.
While a reduced corporate tax rate of 21% can be beneficial to companies, companies should be aware that changes to deductions or credits, discussed below, could off set some of the benefits of the lower tax rate. As such, companies should work together with their accounting teams to identify opportunities to accelerate deductions and defer income as part of their tax planning. Such planning could result in tax savings given the reduction in corporate income tax rate.
Repeal of the domestic production activities deduction
One of the deductions that is repealed by the new tax bill is for domestic production activities under Section 199. The purpose of the domestic production deduction, passed in 2004, was to give companies a tax break on income they earned from making things in the U.S. It was intended to help American manufacturers compete against companies overseas. The repeal of this deduction will be effective after December 31, 2017.
Life sciences companies often engage in manufacturing, production, or service activities that fall within the scope of Section 199. Since taxpayers can make amended return claims for Section 199 deductions, life sciences companies with Section 199 eligible activities may want to review the claims they have already made for additional opportunities or consider making new claims on an amended return to ensure they are maximizing the benefit of the deduction before it is too late.
Change in R&D tax credit
Another area that the new tax bill will impact is the tax credit allowed for research and development (“R&D”). While companies will continue to be allowed to write off many of their research-related expenses, the final tax bill will require companies to write off those costs over a longer period of time.
Under the previous tax law, companies could take deductions immediately and in a single year if they desired. Such a credit is estimated to be worth approximately $10 billion annually to companies. The Senate had initially inserted language in its bill that would have essentially removed the credit entirely, but in a last minute change, lawmakers kept the credit in place, but changed the rules so that companies would have to write off their research-related expenses over 5 or more years instead of in a single year.
By increasing the time period that R&D expenses could be written off, the new tax bill is preventing companies from claiming all their credit in a single year. Life sciences companies will need to work with their accounting teams to determine what impact the prolonged period of time will have on their research and development goals and related tax liability.
Modification of the orphan drug credit
The new tax bill also reduces the credit available to life sciences companies engaged in clinical testing of orphan drugs. Orphan drugs are drugs used for treating rare diseases or conditions affecting fewer than 200,000 persons in the U.S. The previous law allowed companies to write off 50% of the research costs of developing orphan drugs. Under the new tax bill, the credit is reduced by half to 25% and generally would need to exceed 50% of the average expenses over a three-year period. The reduced credit would apply to amounts paid or incurred in tax years beginning after December 31, 2017.
Research expenses that qualify for the orphan drug credit may in many cases also qualify for the research credit. Life sciences companies should evaluate which credit would be better to claim and whether there are opportunities to maximize the benefits of each.
It will be interesting to see how the new tax bill plays out over the next few years and what benefits will be seen by companies in the life sciences sector. While many of the deductions and credits available to these companies will be reduced, companies will still be able to take advantage of an overall reduced federal tax rate. Life sciences companies should begin reviewing their options under the new tax bill and reevaluate their tax accounting methods to identify opportunities to maximize their tax benefits.
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