Case Study: How Orphan Drug and R&D Credits Intermingle

United Therapeutics Corp. v. Commissioner, case number 23-1718, in the Court of Appeals for the Fourth Circuit.


United Therapeutics Corp, a biotechnology company, has brought their case to the Fourth Circuit of Appeals, where they aimed to appeal a decision passed by the US Tax Court. According to the Tax Court, the company’s computation methods resulted in an R&D claim inflated by $1.2 million.

The company first received a notice of deficiency from the IRS in 2021 for an R&D tax credit claim made for the 2014 tax year. The deficiency specified an income tax deficiency of $1,212,655. In 2023, the Tax Court upheld the deficiency. This decision is now being appealed. The issue at hand pertains to the calculation used when claiming both the R&D tax credit (IRC 41) and the Orphan Drug Credit (IRC 45).

The taxpayer used the alternative simplified credit method (ASC) for computing their research credit, which provides a credit equal to 14% of qualified research expenses (QRE) that exceed 50% of the “average qualified research expenses for the 3 taxable years preceding the taxable year for which the credit is being determined.”

Some of the QREs crossover and qualify as clinical testing expenses for the orphan drug credit. When claiming both credits, a coordinating provision in IRC 45C(c)(2) mandates that any qualified clinical testing expenses that are also QREs “shall be taken into account in determining base period research expenses for purposes of applying section 41 to subsequent taxable years”.

The Court of Appeals is reviewing the Tax Court’s opinion that the taxpayer did not appropriately address the coordinating provision under IRC 45C(c)(2). 

Approach Used

The taxpayer incurred expenses that qualified under both credits in the baseline period of 2011-2013. The taxpayer claimed the orphan drug credit in tax years 2011-2014 and elected to claim the R&D credit in tax year 2014 using the ASC method. However, in calculating the average QREs for the 3-year base period, the taxpayer excluded the qualified clinical testing expenses incurred in 2011-2013. These expenses would also be QREs. By excluding these expenses, the resulting average QREs for 2011-2013 were $22,605,492 and resulted in an R&D tax credit of $2,799,129 for the 2014 tax year. 

IRS’ Stance

The IRS disagreed with this method, stating these expenses should have been included in the baseline. If the IRS’s take is correct, the base period QRE should be $49,257,244 and the correct R&D credit would be $1,586,474.


The taxpayer argued that the term “base period research expenses” in IRC 45C(c)(2) was a statutorily-defined term that Congress used in the 1980s version of the IRC 41 research credit (JA.51, 54) that no longer had any meaning in the applicable 2014 version of § 41 (JA.59). 

The Commissioner disagreed, arguing that even though Congress eliminated the term “base period research expenses” from IRC 41, that term continued to operate through IRC 45C(c)(2) to coordinate the two credits. (JA.114, 123.) 

The taxpayer told the Fourth Circuit that the Tax Court was wrong to look at dictionary definitions to establish a base period for the credit calculation. The term “base period” is defined in IRC Section 41, which governs scientific research credits separately from those for clinical testing, as a term that applies only in the calculating of basic research credits, which the company did not apply for, according to its brief.

The Commissioner argued that United Therapeutics has ignored the part of IRC Section 41(e) that says only basic research credits are relevant to the base period. Under the plain meaning of the law, that provision does not extend to IRC Section 45C, which requires all expenses to be included in the credit calculation, the government said.

Appeal Result

The Tax Court sustained the Commissioner’s tax deficiencies, agreeing that IRC 45C(c)(2) should be applied according to its ordinary meaning. Since “base period research expenses” was not a defined term in the 2014 versions of either IRC 41 or IRC 45C, one should turn to the contemporary definition, interpreting “base period” as a baseline or reference point.

With this decision in, the Tax Court correctly relied on current dictionary definitions of a base period in holding that United Therapeutics should have included all its qualified research expenses, including those to develop drugs to treat disease, for the three years leading up to its 2014 credit year. As a result, the taxpayer did in fact claim a credit $1.2 million larger than they were eligible for.

Are you developing new technology for an existing application? Did you know your development work could be eligible for the R&D Tax Credit and you can receive up to 14% back on your expenses? Even if your development isn’t successful your work may still qualify for R&D credits (i.e. you don’t need to have a patent to qualify). To find out more, please contact a Swanson Reed R&D Specialist today or check out our free online eligibility test.

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