How the Tax Cuts and Jobs Act Will Impact the Life Science Industry
Many of the provisions of the Tax Cuts and Jobs Act, that took effect on January 1, 2018, will significantly affect the life sciences industry. Below is an overview of the top three changes likely to be of greatest interest to life sciences companies alongside a few other impactful changes.
1. Lower Corporate Income Tax Rate and Qualified Business Income Deduction
The Tax Cuts and Jobs Act (“Act”) lowers the corporate tax rate to 21%, down from 35%, which was among the highest in the industrialized world, to incentivize US investment and allow US companies to be more competitive. The new laws also require a “blended” tax rate for fiscal year taxpayers for their fiscal year that includes January 1, 2018.
However, in order provide a similar incentive to owners of flow-through entities (partners, S corporation shareholders and sole proprietors), the Act gives a tax break to certain business owners within these entities. Certain qualified sole proprietors, S corporation shareholders and partners in a partnership will be allowed a deduction equal to 20% of their allocable share of business income.
The 20% deduction has significant limitations, including:
- Generally, the deduction cannot exceed the greater of 50% of the owner’s share of the W-2 wages paid by the business, or 25% of the owner’s share the W-2 wages paid by the business, plus 2.5% of the unadjusted basis (the original purchase price) of depreciable property used in the business.
- Certain “personal service businesses” are not eligible for the deduction, including accountants, doctors, lawyers, consultants and other primarily service-based businesses.
- The deduction is further limited to 20% of the taxpayer’s ordinary income.
Neither the W-2 limitations nor the service business limitations apply if the taxpayer’s taxable income is less than $157,500 (if single; $315,000 if married filing jointly). The exception to the W-2 limit and the general disallowance of the deduction to personal service businesses is phased out over a range of $50,000 of income for single taxpayers and $100,000 for married taxpayers filing jointly. Thus, by the time income reaches $207,500 (if single; $415,000 if married filing jointly), the W-2 limitation will apply in full, and owners of personal service businesses will receive no portion of the 20% deduction.
2. Orphan Drug Credit
The Tax Cuts and Jobs Act reduces the orphan drug credit from 50% to 25% of the amount of qualified clinical testing expenses for such tax year. Moreover, taxpayers can elect a reduced credit in lieu of reducing allowable deductions in a manner similar to the Section 280C election for the research credit.
3. Amortization of Research and Experimental expenses
The Tax Cuts and Jobs Act requires taxpayers to treat research or experimental expenditures as chargeable to a capital account and amortized over five years (15 years in the case of foreign research) as opposed to previously deducting such expenditures currently under Section 174.
Other business changes
Below is a quick look at other business changes under the Tax Cuts and Jobs Act, as they compare to prior law:
|Prior Law||Current Law|
|Availability of cash method for C corporations||avg receipts < $5M||avg receipts < $25M|
|Availability of cash method for taxpayers with inventory||limited to Rev. Proc. 2001-10 and Rev. Proc. 2002-28||avg receipts < $25M|
|Exclusion from Section 263A||limited to resellers with avg. receipts < $10M||avg receipts < $25M|
|Section 179 limitation||$510,000||$1,000,000|
|100% expensing||n/a||through 2022, then phase down over five years|
|Interest expense deduction||unlimited||limited to 30% of adjusted taxable income if avg receipts > $25M|
|Net operating losses||carry back 2 years, forward 20||no carry backs, carry forwards limited to 80% of taxable income|
|Section 199 deduction||allowed for domestic production||eliminated|
It is important to note that the ability to deduct 100% of the cost of qualifying assets is effective retroactive to September 27, 2017. Thus, businesses need not wait until 2018 to benefit from these rules.
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|Stephen J. Talkowsky, CPA, JD, LLM, Partner