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Formulating Tax Benefits: R&D Credits in the Pharmaceutical Industry

The pharmaceutical industry continues to lead the way in scientific innovation, harnessing the power of research and development to produce life-altering treatments and therapies. This ceaseless commitment to advancement is considerably incentivized by R&D tax credits, a significant factor underpinning industry innovation. These crucial incentives, offered by the federal government, are designed to reward companies who invest in research activities, keeping America at the forefront of global medical breakthroughs.

Scienist performing an experiment

The Significance of R&D in the Pharmaceutical Industry

Pharmaceutical companies allocate a substantial portion of their revenue to R&D, surpassing other knowledge-intensive industries. In 2021, member companies of The Pharmaceutical Research and Manufacturers of America (PhRMA) trade group spent approximately $102 billion on pharmaceutical industry research, allocating 24% of their collective revenues to R&D spending within the U.S. market. This investment is a testament to the industry's commitment to innovation and the development of new treatments and therapies.

The Role of R&D Tax Credits in Pharmaceutical Innovation

R&D tax credits play a crucial role in supporting the pharmaceutical industry's innovation efforts. By offsetting a portion of the costs associated with research and development, these credits make it more financially feasible for companies to invest in new drug development, clinical trials and other qualifying activities. This, in turn, can lead to breakthroughs in treatments and therapies that improve patient outcomes and advance medical science.

Qualifying Activities for R&D Tax Credits

R&D spending in the pharmaceutical industry typically follows a process that includes:

  • Invention
  • Development
  • Incremental innovation
  • Product differentiation
  • Safety monitoring or clinical trials

IRS Guidelines for Pharmaceutical Industry Research Credits

According to the IRS' Pharmaceutical Industry Research Credit Audit Guidelines, the pharmaceutical product development process can be divided into four stages:

  1. Preclinical/Discovery Research: This is the stage where new compounds are discovered.
  2. Clinical Development: This stage is conducted in three phases:

Phase I: Initial trials in humans that test a compound for safety, tolerance and pharmacokinetics. These trials usually involve healthy volunteers.

Phase II: Pilot studies to determine efficacy and safety in selected populations of patients with the disease or condition to be treated, diagnosed or prevented. Dose and dosing regimens are determined during this phase.

Phase III: Expanded clinical trials intended to gather additional evidence of effectiveness for specific indications and to better understand safety and drug-related adverse effects.

  1. Regulatory Review: The New Drug Application (NDA) is submitted to a regulatory agency, such as the Food and Drug Administration, for marketing and manufacturing approval.
  2. Post-Marketing: These activities occur after approval to market has been granted by the appropriate regulatory agency. These activities include Phase IV studies performed to determine the incidence of adverse reactions, the long-term effect of a drug, to study a patient population not previously studied and for marketing comparisons against other products and other uses.

When evaluating an R&D tax credit claim, the IRS seeks documentation such as tax work papers, qualified wages, qualified supplies, qualified contract research, interviews, a tour of the research facility, an organizational chart and job titles, grade levels and position descriptions.

Getting an R&D Tax Credit Analysis to see if you qualify is the first step! 

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