How to Claim R&D Tax Credits for Pharmaceutical Companies in 2024

The pharmaceutical industry is known for constant innovation. Thus, it’s no surprise that most pharmaceutical companies qualify for the government’s research and development tax credit. The issue is figuring out how much to claim.

That’s what this article is here to help with. We'll explore how pharmaceutical companies can claim R&D tax credits for pharmaceutical companies in 2024 to maximize their return effectively and efficiently.

What is the R&D Tax Credit?

The research and development tax credit encourages businesses to innovate and think ahead. It credits an average of 6.5-10% of QREs (Qualified Research Expenditures) including wages, supply costs, and contracted research expenses.

The R&D tax credit applies mainly to small and medium-sized businesses. It provides tax incentives for:

• Developing new products or services
• Improvements in old products or services
• The creation or testing of new prototypes 

How Does the Research & Development Tax Credit Work?

The R&D tax credit provides tax breaks to companies that conduct research and develop new products, improvements, and other innovations.

If the firm has been in business for less than 5 years and has less than 5 million in gross receipts, the R&D tax credit can be applied to payroll taxes. This allows firms that have yet to profit to benefit.  

Can Pharmaceutical Companies Claim the R&D Tax Credit?

Yes, pharmaceutical companies are eligible to claim the R&D Tax Credit. The credit is designed to encourage companies to invest in their own research and development, improving their industry and keeping ahead of the technological curve. 

The credit itself is available to companies of all levels and sizes, from startups to multinationals.

For the pharmaceutical industry, the credit can be claimed for a wide range of R&D activities, such as the development of new drugs, medical devices, or improved manufacturing processes.

How to Claim R&D Tax Credits for Pharmaceutical Companies

To claim the R&D tax credit safely, you’ll need to understand the eligibility criteria and the documentation requirements: 

Check Your Eligibility

Your company’s eligibility for the R&D tax credits depends on projects that qualify as research expenses. To check whether a given project qualifies, you can use the four-part test, which is the IRS’s method of determining qualifying research expenses. 

Here are some of the typically qualifying activities in the pharmaceutical industry:

• Developing new pharmaceuticals or medical devices
• Improving existing products or manufacturing processes
• Conducting clinical trials or testing
• Designing and developing new packaging or labeling systems

Then, the following are the kinds of expenses that can be claimed for the credit:

• Wages and salaries of R&D personnel
• Materials and equipment costs
• Contract research expenses
• Software and technology costs

The Four-Part Test

To qualify for the R&D Tax Credit, your projects must be engaged in activities that pass the four-part test that was created by the precedent set by the 2023 IRS case:

1. Permitted Purpose – The project aims to create or improve the functionality, performance, reliability, or quality of a business component.
2. Elimination of Uncertainty – The project begins with uncertainty about how to achieve the project goal and involves work to eliminate this uncertainty.
3. Process of Experimentation – The project involves a systematic process of experimentation by evaluating one or more alternatives.
4. Technological in Nature – The experimentation relies on the hard sciences, such as engineering or computer science.

Although still somewhat subjective, using previous examples to show that one’s efforts fall within the four parts is the most straightforward way to claim your case.

Speak to a Tax Planning Team

After you’ve determined that some of your projects may be eligible, it’s time to consult with a tax professional or R&D tax credit expert, who will be able to help you best take advantage of the credit. 

Our team at RevenueSafe is one such team that specializes in helping companies with the R&D tax credit. 

By following these steps, pharmaceutical companies can take full advantage of the R&D Tax Credit and maximize their refund. 

Examples of R&D for Pharmaceuticals

More than most industries, the pharmaceutical industry performs a wide range of qualifying R&D activities. Here are 3 concrete examples to get a better idea of what qualifies:

1. Developing a new class of antibiotics to combat antibiotic-resistant bacteria: Let’s imagine a company that spends 2 years researching and developing a novel antibiotic by conducting extensive lab tests and clinical trials. This activity is a classic case of what qualifies for the R&D tax credits for pharmaceutical companies, as the experimentation and testing used to create a new product are clearly qualified research activities.

2. Improving the manufacturing process for a popular diabetes medication: Let’s say a company invests in R&D to optimize its production process for its best-selling diabetes medication. This new process reduces waste, increases the drug yield, and generally improves the quality of the drug. Since this improvement requires a process of experimentation and testing to improve, it also qualifies for the R&D tax credit for pharmaceuticals.

3. Creating a novel drug delivery system for cancer treatment: Third, research into new delivery systems or medical devices also qualifies. In this case, we might have a company that develops a new delivery system for their medication that better targets cancer cells in the body. Since developing this system involves extensive testing, clinical trials, and all the usual checks and balances of pharmaceutical development, it also qualifies for the R&D tax incentives for pharmaceutical companies.

How The IRS Calculates the R&D Credit

The IRS uses two primary methods for calculating the R&D tax credit: the traditional and the Alternative Simplified Credit (ASC) method.

1. Traditional method – Document and calculate 20% of research expenses over a base amount. The base amount is a fixed-base percentage multiplied by the average annual gross receipts for the last 4 years.
2. Alternative Simplified Credit (ASC) method – This method calculates the credit based on 14% of the qualified research expenses (QREs) that exceed 50% of the average QREs for the 3 preceding tax years. If the company had no research expenses in any of the previous three years, the credit is 6% of the QREs for the current year​​.

The approach you should choose depends on the calculation method that best suits a company’s financial situation and R&D spending patterns.

How Much Can Pharmaceutical Companies Earn from the R&D Tax Credit

The credit amount is based on the company's qualified R&D expenses and can range from 6% to 20% of eligible expenses for pharma firms. This makes the R&D Tax Credit a worthwhile source of revenue for all pharmaceutical companies.

The credit amount is determined by applying the applicable credit rate to the total qualified R&D expenses. Here are 2 examples:

1. If a pharmaceutical company has $1 million in qualified R&D expenses and is eligible for a 20% credit rate, the credit amount would be $200,000.
2. If a pharmaceutical company has $500,000 in qualified R&D expenses and is eligible for a 10% credit rate, the credit amount would be $50,000.

However, the final credit amount varies widely depending on several factors, including:

1. The company's qualified R&D expenses: The higher the R&D expenses a company incurs, the higher the potential credit amount.
2. The applicable credit rate: The credit rate can vary depending on the company's location, industry, and type of R&D activities.
3. The company's tax situation: The credit amount may be affected by the company's tax liability, net operating losses, and other tax factors.

To maximize the R&D Tax Credit, you should:

• Maintain accurate and detailed records of all R&D expenses and activities.
• Identify and claim all eligible R&D expenses, including wages, materials, equipment, and contract research expenses.
• Consult with a tax professional or R&D tax credit expert to ensure compliance with regulations.

Frequently Asked Questions

How Far Back Can You Claim R&D Tax Credits?

You can claim R&D Tax Credits for the last 3 tax years.

If your company has missed out, you still have a chance to amend past returns and get the credit.

This could lead to significant savings on already completed research and development initiatives.

What is the Deadline to Claim the R&D Tax Credit for Pharmaceutical Companies?

The deadline to claim the R&D tax credit is normally three years from your original filing deadline. Some exceptions apply.

Can Pharmaceutical Companies Claim the R&D Tax Credit for Failed Projects?

Yes, pharmaceutical companies can claim the R&D Tax Credit for failed projects.

The requirements are similar to successful projects, so it is eligible as long as the expenses claimed were spent in pursuit of a qualified research project. 

How Should Pharmaceutical Companies Document R&D Expenses?

Pharmaceutical companies should meticulously document their R&D expenses, including employee time, materials, and equipment costs.

This documentation is crucial in the event of an audit, providing concrete evidence of qualifying expenses.

What Doesn’t Qualify for the Credit in the Pharmaceutical Industry?

Not all R&D activities within the pharmaceutical industry qualify for the R&D credit. Some examples of expenses that don't qualify for the credit include:

• Routine testing and quality control
• Cosmetic changes to existing products
• Market research and marketing expenses

Start Your R&D Claim - Do You Qualify?

At RevenueSafe, we explore a business’s R&D methods and expenses to ensure a compliant claim of maximum value. Our process is simple, straightforward, and easy to use. So don’t wait, take the opportunity now to save money for your business.