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Pharmaceutical Companies Reap Significant Tax Benefits: The Orphan Drug Tax Credit


Jonathan Cardella

Strike Summary

  • There are certain restrictions when taking advantage of both Sections 174 deduction/capitalization and Section 41, which can be seen in Section 280C.
  • Businesses that choose to elect Section 280C for their federal taxes could also lower their state taxes as well.
  • Taxpayers that want to use Section 280C must plan ahead because it can only be used on an originally filed return.
  • The recent passage of the Tax Cuts and Jobs Act may have have affected whether a taxpayer should use Section 280C in their tax strategy.

Work with Strike to navigate tax changes with ease.

Schedule a MeetingBook a Consultation

Strike Summary

  • The Orphan Drug Tax Credit is specifically for research on diseases that affect less than 200,000 people in the U.S.
  • The ODTC and the R&D tax credit have similar purposes, but differ in three critical ways.
  • Since 1983, when the ODTC was passed, over 600 novel drugs have been developed.


The Orphan Drug Act was passed in 1983 under IRC Section 45C to incentivize pharmaceutical companies to develop treatments for rare diseases, defined as conditions affecting fewer than 200,000 people in the United States. The term “orphan” was coined because drug companies were not interested in developing treatments or cures for these conditions due to their limited markets and tremendous research and development costs. The Orphan Drug Tax Credit (ODTC) allows companies to claim up to 25% of the qualified clinical testing expenses (QCTEs) in the current year and three prior years to offset their investment in rare (orphan) conditions. The credit includes other benefits such as enhanced patent protection, marketing rights, and clinical research subsidies.

By lowering development costs, the Orphan Drug Tax Credit (ODTC) encourages companies to move testing from the lab into clinical trials, and subsequently (and ideally), to FDA-approved treatments and cures. It is estimated that even a small trial for an orphan drug, with no control group and less than 15 enrolled patients, can cost up to $5 million (1).

Because third-party contractors (clinical research organizations, CROs) conduct an increasing proportion of clinical trials in the U.S. and worldwide, the tax savings could be significant. In fact, the global CRO market is expected to reach $57.1 billion by 2025 (2), and costs associated with orphan drug trials can be offset by the ODTC through a dollar-for-dollar tax credit.

The Orphan Drug Tax Credit Versus the R&D Tax Credit

Both the ODTC and the R&D Tax Credit (under IRC Section 41) aim to spur U.S.-based research and innovation, but the ODTC offers greater incentives than the standard research and development R&D tax credit. For a company conducting clinical research for a non-orphan disease, the standard R&D tax credit applies. Companies can claim 100% of qualified employee wages and supplies, and 65% of the cost of third-party contractors involved in R&D. These (wages, supplies, contractors) are termed qualified research expenses (QREs), and companies can recoup a federal tax credit equal to approximately 10% of the total R&D QREs each year.

Most states also have some form of the R&D credit to offset various state tax liabilities. Some companies can even claim credits in multiple states.

Importantly, for the R&D tax credit, the activities qualifying for expenses must be conducted in the U.S., and unlike the R&D tax credit, the ODTC does not have a provision that allows companies a payroll tax credit.

When claiming the ODTC, the same QREs are calculated, but the ODTC differs in three significant ways from the standard R&D tax credit:

  1. Contractor costs can be claimed at 100% (instead of 65%);
  2. Companies recoup 25% of QREs (instead of 10%); and
  3. Clinical trials conducted outside the U.S. are considered QREs if there is an insufficient testing population in the U.S.

How to Claim the Orphan Drug Tax Credit 

The first step in filing for the ODTC is to receive orphan drug designation from the FDA (3). Orphan drug designation makes the drug eligible for the benefits of the ODTC. Only qualified clinical testing expenses that occur between orphan drug designation and FDA approval can be claimed. Therefore, it is important for companies to closely track expenses that are incurred between these two designations.

As additional incentives, the tax code offers NDA/BLA fee waivers and a seven-year period of marketing exclusivity for an FDA-approved orphan treatment. Research expenditures outlaid prior to human trials, during the in vitro and pre-clinical testing phases of drug discovery, should be claimed under the standard R&D tax credit. Companies cannot claim the ODTC and the R&D tax credit for the same research expenses, and it is important to carefully document and separate the QREs that apply to each of the credit claims.

Claiming the ODTC (and the R&D tax credit) requires an in-depth determination of qualified expenses, which is best left to tax professionals. Contact Strike to speak with our industry experts and see how you can reduce the cost of developing your company’s next new treatment or cure.

Benefits of Drug Research and Development Credits

Despite the rare disease moniker, the Genetic and Rare Diseases (GARD) information center, a program within the National Institutes of Health, estimates there are more than 7,000 orphan diseases affecting anywhere from 25-30 million Americans (4). Diseases with orphan designation include amyotrophic lateral sclerosis (ALS, or Lou Gehrig’s Disease), Tourette syndrome, and many rare cancers and infectious diseases. While the number of individuals suffering from a specific disease may be small, in the aggregate there are millions of people affected by these disorders.

Before the ODTC, there was little incentive for drug companies to divert resources to these conditions. First, there is a small pool of affected people such that enrolling participants in clinical trials is exceedingly difficult, and second and more importantly, there is a limited target population for the approved drug once it hits the market. These concomitant issues translate into little (if any) return on investment. To counteract these deterrents and encourage investment into research for the development of novel treatments, the federal government offers generous tax incentives to companies pursuing treatments for rare diseases.

The Orphan Drug Act is credited with greatly increasing the number of available treatments for these rare conditions. Since the bill passed in 1983, the FDA Office of Orphan Products Development has supported the development of more than 600 drugs and biologic products for rare diseases. In comparison, less than 10 industry-driven products came to market between 1973 and 1983 (5).


  1. Moore TJ, Zhang H, Anderson G, Alexander GC. Estimated Costs of Pivotal Trials for Novel Therapeutic Agents Approved by the US Food and Drug Administration, 2015-2016. JAMA Intern Med. 2018;178(11):1451–1457. https://pubmed.ncbi.nlm.nih.gov/30264133/ 
  2. https://www.reportlinker.com/p05885916/Global-Healthcare-CRO-Services-Market-By-Service-Type-By-End-User-By-Therapeutic-Area-By-Region-Industry-Analysis-and-Forecast.html?utm_source=GNW
  3. https://www.fda.gov/industry/developing-products-rare-diseases-conditions/designating-orphan-product-drugs-and-biological-products
  4. https://rarediseases.info.nih.gov/diseases/pages/31/faqs-about-rare-diseases
  5. https://www.fda.gov/industry/developing-products-rare-diseases-conditions

Work with Strike to navigate tax changes with ease.

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