R&D credit opportunities for life sciences organizations
Pharmaceutical, biotechnical, agricultural, medical device and biomedical organizations live in a constant state of innovation. The ever-changing technological landscape creates opportunities for driving ideas forward. Many seemingly day-to-day operations are rife with research and development that may qualify for a tax incentive.
To highlight a specific example, artificial intelligence (AI) has dramatically influenced the way pharmaceuticals and medical devices are discovered, manufactured and consumed. The market for AI in drug development alone jumped to $700 million in 2018 from $200 million in 2015, and is expected to continue that growth but at an even quicker pace, with reports estimating market value to reach more than $4 billion in 2024.
Fortunately, federal and state governments offer R&D tax credits to life sciences organizations of all sizes to offset expenses and allow companies to reinvest in themselves. An extensive range of technical activities within the industry qualify for the credit, yet are often overlooked by organizations. Consider the examples below:
- Designing new drugs, chemical compounds or medical devices
- Repurposing or reformulating existing drugs
- Improving the shelf life of a product
- Developing new or unique delivery systems or blending technology for compounds or medicines
- Designing and executing experiments or trials
- Generating prototypes of new products
- Implementing automation processes or robotics
- Developing or improving manufacturing processes
- Researching new technology to incorporate into products
- Developing scientific theories and research methods
Activities must meet four government-specified criteria in order for an organization to include the associated taxable wages, supplies and/or contract research in the calculation of the R&D tax credit. Companies should also note the activities need only be evolutionary to the organization itself, not to the industry as a whole in order to qualify.
1. The activity must be technological in nature. The activity must be based on the principles of the following hard sciences:
a. Engineering
b. Computer science
c. Physical science
d. Biological science
2. The activity must be for a permitted purpose. The activity must involve the creation of a new or improved level of:
a. Function
b. Performance
c. Reliability
d. Quality
3. The activity must involve the elimination of uncertainty. The activity must explore what was not known at the start of the project:
a. Capability uncertainty – Can we develop it?
b. Methodology uncertainty – How will we develop it?
c. Design uncertainty – What is the appropriate design?
4. The activity must involve a process of experimentation. Substantially all activities must include elements of experimentation:
a. Evaluating one or more alternatives
b. Performing testing or modeling
c. Examining and analyzing hypotheses
d. Refining or abandoning hypotheses
The following case study demonstrates how life sciences organizations can take advantage of the R&D credit:
Case study
Company: A young Minnesota-based medical device company in the development and testing stages for a device and delivery system
Business challenge: Initially, the company did not see the value in pursuing the R&D credit due to the fact it had not generated taxable income in its first three years. Many new or small companies are not aware of the carryforward or payroll tax opportunities associated with the R&D tax credit. The credit can be carried forward for up to 20 years if unable to use in the current year. Additionally, businesses with gross receipts in five years or less and under $5 million in gross receipts are considered eligible small businesses and may apply the R&D credit against their payroll tax. Once informed, the organization saw the huge benefit the credit could provide.
Approach: The R&D advisory team assisted the company in identifying, quantifying and calculating federal and state R&D tax credits. On-site and telephone interviews were conducted to gain an understanding of the organization’s projects, activities and expenses, and to identify any credit opportunities. A methodology was developed to align with the company’s current processes and procedures for identifying and recording projects and activities.
The following are the organization’s qualifying activities we identified during the interview process:
- Developing a new medical device
- Generating prototypes of the new device for testing
- Testing through animal trials and patient compassionate use scenarios
- Researching new delivery system methodologies
Results: The company generated more than $700,000 in gross federal R&D tax credits and over $200,000 in Minnesota credits. Additionally, we implemented a thorough reporting and documentation methodology for the organization to substantiate qualifying activities and expenses for the current year and going forward.
Senior consultants Emma Finney and Ashley Reed contributed to this article.
For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
