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Tax Law

IRS Issues Form 8942 and Instructions for New Section 48D

On June 17, the IRS released Form 8942, Application for Certification of Qualified Investments Eligible for Credits and Grants Under the Qualifying Therapeutic Discovery Project Program, (the form) and its instructions. As we described in our May 24 Life Sciences Tax Alert ("IRS Issues Notice 2010-45 with Application Criteria for New Section 48D"), to qualify for the credit, taxpayers must receive a certification from the IRS that they have a Qualifying Therapeutic Discovery Project (QTDP) before they claim the credit on a federal income return or receive a grant in lieu of the credit.

Background on Section 48D and Notice 2010-45

The Health Care and Education Reconciliation Act established the investment tax credit for certain expenditures related to a QTDP made in 2009 or 2010 under the newly created Section 48D for eligible taxpayers with fewer than 250 employees.1 The federal credit is equal to 50 percent of the aggregate costs paid or incurred in a taxable year that are directly related to a QTDP. Importantly, the new provision also permits the Treasury to provide taxpayers with a grant in lieu of the tax credit so that even companies who are unable to use the tax credit to offset future income may be able to receive the cash grant.

A QTDP is a project that is designed to develop a product, process, or therapy to diagnose, treat, or prevent diseases and afflictions by: (1) conducting pre-clinical activities, clinical trials, clinical studies, and research protocols, or (2) by developing technology or products designed to diagnose diseases and conditions, including molecular and companion drugs and diagnostics, or to further the delivery or administration of therapeutics.

The IRS previously issued Notice 2010-45 (the notice), which provided guidance on the necessary information required to be submitted by taxpayers seeking a recommendation from the U.S. Department of Health and Human Services, as well as information to be supplied to the IRS for certification. The notice also provided a series of helpful definitions and rules for eligible applicants and forecasted the information that was then contained in the form.

Since the release of the notice, the National Institute of Health (NIH) and IRS have posted various questions and answers on their Web sites.2

Some of the information can be found in the notice, however, a few items have been clarified:

1. Are legal expenses related to the protection of intellectual property rights eligible to be qualified investments?

No. Generally, legal and/or accounting fees are not considered qualified investments. Notice 2010-45, section 4.01(3), states that "the qualified investment for any taxable year with respect to any qualifying therapeutic discovery project will not take into account any cost ... (d) that is identified as a service cost under Treas. Reg. Section 1.263A-1(e)(4) of title 26, Code of Federal Regulations ..." Legal services are identified as a service cost in Treas. Reg. Section 1.263A-1(e)(4).

2. Can licensing fees paid to the NIH, the Department of Defense, the Center for Disease Control, other federal agencies, or universities in order to use or gain access to drugs, cell lines or other biological materials or substances in which the federal government or a university holds the licensing rights or otherwise requires payment in order to use or access the materials or substances be included in qualified investment?

Qualified investment is the aggregate amount of the costs paid or incurred that are directly related to the qualifying therapeutic discovery project. If licensing fees are directly related to a qualifying therapeutic discovery project, then they generally may be treated as a qualified investment.

3. Because most applicants will not know if they will receive a credit or grant under Section 48D for 2009 until after the due date with extensions for filing an income tax return for the 2009 tax year, how should taxpayers that normally claim a credit under Section 41 or Section 45C handle that item on their 2009 tax returns?

Such applicants should file a return for 2009 under the assumption that they will not be receiving a credit or grant in lieu of credit under Section 48D. If an applicant is certified by the IRS for a 2009 Section 48D credit or grant in lieu of credit, then the IRS will provide special processing instructions for the filing of amended 2009 returns to reflect any reduction in credits under Sections 41 and 45C.

One of the more helpful documents on the Web site is the QTDP Reviewer Response Sheet, which provides applicants with a glimpse into how NIH will score the applications. The sheet details why reviewers might "reject" applicants' responses to the first eight questions and how reviewers might have arrive at their one-to-five scoring for questions nine through 11. The Web site also has a helpful document, "Description of QTDP Review Process," which is a flowchart diagramming the recommendation process based on the scoring described above, giving applicants a sense of how the competition will be judged.

Form 8942 and Project Information Memorandum

The form along with the Project Information Memorandum (PIM) can also be found on the NIH Web site.3 The form and its instructions generally conform to the information contained in the notice. There are a few points to note, along with a few unanswered questions. For example, Question 22 asks the taxpayer to enter the number of contractors in the United States paid for work on this project by collecting their average monthly hours and average monthly compensation. For eligible taxpayers contracting with clinical research organizations, it may be difficult to obtain this information from the third-party vendor, since the contractors are indirectly working for the taxpayer on the project. The form and instructions don't seem to answer one open question: if an eligible taxpayer enters into a collaboration agreement with a third party and is getting reimbursed for its research and development expenses under the agreement, do the otherwise eligible expenses still qualify for the grant?

Pepper Perspective

As mentioned in our previous Alerts, this is expected to be a very competitive process with a short time frame to submit the applications (applications are due on or before July 21, 2010). Applicants are encouraged to follow all of the instructions on the form and the PIM carefully since applications that fail to comply with the instructions set will not be considered.

Author Todd B. Reinstein also will speak on this topic, along with Brandon Carlton, attorney-advisor in the Office of the Tax Legislative Counsel, U.S. Treasury Department's Office of Tax Policy, during a Federal Bar Association Section on Taxation webinar, "Section 48D Qualified Therapeutic Research Projects Program and Form 8942," on Monday, June 28, 2010 from noon to 1 p.m. EDT. For more information and to register, please contact Adrienne Woolley at or 571.481.9100. Registration deadline: June 25.


1 Unless otherwise stated, all references to "Section" are to the Internal Revenue Code of 1986 (the "Code"), and all references to "Treas. Reg. Section." are to the Treasury Regulations promulgated thereunder (the "Regulations").

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This article is republished with permission of Pepper Hamilton, LLP. Further duplication without the permission of Pepper Hamilton, LLP is prohibited. All rights reserved.