Orphan drug tax credit

The orphan drug credit under Section 45C equals 25 percent of qualified clinical testing expenses for a drug designated by the FDA for a rare disease or condition. It applies to costs incurred after designation and before approval, for human clinical trials conducted in the United States or, in limited circumstances, abroad. Before 2018 the rate was 50 percent.

Costs used for the orphan drug credit cannot also be used for the regular research credit, so companies allocate between them. The credit is non-refundable and cannot offset payroll taxes, so for a loss-making company it accumulates as a carryforward, available for twenty years, and becomes valuable when the company reaches profitability or is acquired by a profitable buyer.

The credit is one reason rare disease companies carry large deferred tax assets, fully reserved by a valuation allowance, and one of the tax attributes that gets valued in an acquisition, subject to Section 382 limits.