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A new tax credit worth up to 50 percent of the cost of investments in a “qualifying therapeutic discovery project” is part of the sweeping health care legislation passed in March this year.

The credit is available only to companies with 250 or fewer employees (counting employees of all related businesses) and applies only to investments made in taxable years beginning in 2009 and 2010.

For companies that are not yet profitable and thus cannot benefit currently from tax credits, grants will be made equal to the amount of the credits that would have been available.  The maximum credit or grant for a company is $5 million.

Only companies that are approved to participate in the program will be eligible for credits or grants.  The IRS has issued detailed guidance on the program in Notice 2010-45 (May 21, 2010), and an information release.

• Applications should be made on IRS Form 8942, which is available here.  The instructions to Form 8942 explain how to complete and submit an application to participate in the program.
• Completed applications must be filed with the IRS by July 21, 2010.  The IRS, in consultation with the Department of Health and Human Services, will certify which applicants may participate based upon a number of criteria. Decisions will be made by the end of October, 2010.

One important limitation is that grants will not be available to any federal, state or local government (or government instrumentality or agency) or any organization that is tax exempt under Section 501(c).  Moreover, grants will not be available to any partnership or other pass-thru entity (such as an LLC or S corporation) if any direct or indirect partner or other owner  is a government entity or a 501(c) tax-exempt organization. Many early stage and smaller R&D companies are organized as LLCs and have government or tax-exempt investors.  For example, a tax-exempt university might have taken an equity interest in the LLC in lieu of other consideration for a technology license.  Moreover, although it is not clear what an “indirect partner” in a company means, it is possible that it would include a government or tax-exempt entity that is a limited partner in a venture capital fund that has invested in the company.

Due to this limitation, the pool of applicants for the new grants may be considerably smaller than Congress intended.  Unless some relief is made available, many intended beneficiaries of the new program will not be able to take advantage of it.  If an LLC with a tax-exempt entity as an investor is otherwise a good candidate to receive a grant under the program, it might consider restructuring the ownership of the LLC by means of a transfer or redemption of the interest held by the tax-exempt entity. Of course, such a restructuring would require careful planning if it is to be respected by the IRS.

Another question is whether a non-US entity may participate in the program.  The legislation provides that, when awarding credits or grants, the IRS should take into consideration whether the project is among those projects that have the greatest potential to create high-quality, high-paying jobs in the United States and to advance United States competitiveness in the fields of life, biological and medical sciences.  While this should not preclude an award of a credit or grant to a foreign entity, the foreign entity will need to address these factors to be competitive with other applicants.

Note: A “qualifying therapeutic discovery project” includes any project designed:

• to treat or prevent diseases or conditions by conducting pre-clinical activities, clinical trials and clinical studies, or carrying out research protocols, for the purpose of securing approval of therapeutics,
• to diagnose diseases or conditions or to determine molecular factors related to diseases or conditions by developing molecular diagnostics to guide therapeutic decisions, or
• to develop a product, process or technology to further the delivery or administration of therapeutics.

For further information about this program, please contact:

Michael K. Barron

Joseph A. Hugg

Dov Lader