Weekly Policy Update: Tax and Investment Implications within the Budget Reconciliation Package
By: Colorado BioScience Association Date: 10/01/2021
In addition to the price-setting policies from H.R. 3, which are already included in House Democrats’ version of the 10-year, $3.5 trillion spending plan, two tax policies along with changes to retirement plans will also have impacts on the life sciences ecosystem: the Orphan Drug Tax Credit and the Capital Gains Tax Rate.
Budget Reconciliation Package Update
The budget reconciliation package’s movement through the House of Representatives was slowed this week as Congress worked to approve a Continuing Resolution (CR) to fund the government through early December. And while the CR was approved it leaves another key legislative issue on the table which Congress will need to address in the short term as to if the debt ceiling should be raised or suspended. Ultimately, these delays allow CBSA and our partners more time to engage Members of Congress on the full scope of harm the policies contained within the package will have on our ecosystem.
Congress enacted the ODTC in 1983 to encourage biotechnology and pharmaceutical companies to develop therapies for rare diseases and conditions. The credit can be taken on qualified clinical testing expenses incurred for FDA-designated orphan drugs. Prior to the Orphan Drug Act’s passage in 1983, there were less than 40 drugs approved in the United States specifically to treat rare diseases. Since 1983, over 500 orphan drugs (as of May 2019) have been granted FDA approval.
Congress last addressed the ODTC as part of the Tax Cuts and Jobs Act of 2017, where the credit was halved from 50% to 25%. And under the current House proposal, drug manufacturers would be ineligible to collect the ODTC if the drug had previously been approved by the FDA for a separate indication. This change would upend the decades of proven success the ODTC has had for companies developing innovative treatments and would ultimately be a regressive policy change that negatively impacts patients suffering from rare diseases.
Under the current proposal, the highest capital gains tax rate would increase to 25% from 20% and this increase would retroactively apply to capital gains recognized after Sept. 13, 2021. And for the tax year 2022, individuals could face a maximum 31.8% combined tax rate on long-term capital gains. This a combination of the base 25% capital gains rate, plus a 3.8% net investment income tax, and 3% high-income surtax. Additionally, the holding period for carried interest would be extended from three years to five years.
We can look at the success of state-run tax credit programs like the Advanced Industries Investment Tax Credit to know that venture capitalists and angel investors look for tools and other strategies to help reduce the risk of their investments in biotechnology and pharmaceutical companies, particularly when they are in the pre-revenue start upstage. And any increase in the tax rate for those investors would likely cause increased hesitation before significant investments are considered in the future.
The package would make two notable changes to the investments that may be made in an IRA. These changes would be effective starting in 2022 and would have a two-year grace period for investors to address any existing investments that are no longer in compliance. The purpose of these changes is to limit the ability of certain IRA owners to invest in investments that aren’t generally publicly available, for example, opportunities open only to “Accredited Investors”.
The first restriction prohibits IRAs from investing in any security where the issuer of the security requires the investor to:
- Have a specified minimum of income or assets;
- Have completed a specified level of education; or
- Hold a specific license or credential.
The second change would prohibit an IRA to be invested in any investment where the IRA owner owns 10% or more of the entity a which is a significant decrease from the current ownership threshold of 50% or where the IRA owner is an officer or director.
These changes would require impacted IRA owners to adjust their investments and allocations in the near future to maintain compliance. These adjustments would likely result in the divestment of businesses and investments held in an IRA, which in turn would impact companies’ future access to sources of capital. Moreover, the change in the ownership threshold is particularly impactful for early-stage life sciences companies that typically have significant investments made by an owner who is also an officer or director.
CBSA advocates for proposals that strengthen the incentives necessary to sustain innovation in the life sciences and create high-wage, high-value jobs. Whether it is related to trade, intellectual property rights, or tax incentives we will continue to make the case to policymakers that these sweeping policy efforts will have sustained impacts on our state’s life sciences ecosystem.