Orphan Drug Credit

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Orphan Drug Credit: What It Is and How It Works

Introduction

The orphan drug credit is a federal tax incentive designed to encourage pharmaceutical development of treatments for rare diseases. It helps offset the high cost of clinical testing for drugs that target small patient populations that otherwise would be unattractive to commercial development.

Key benefits and incentives

  • Tax credit equal to 25% of qualified clinical testing expenses for qualifying orphan drugs.
  • FDA incentives that often accompany orphan designation, including a rebate or waiver of certain application fees and a seven-year period of market exclusivity for approved orphan drugs.
  • Ability to claim the credit whether clinical testing is performed in-house or contracted out; testing is generally required to take place in the United States.

Definitions and eligibility

  • Rare disease (or condition): one that affects fewer than 200,000 people in the United States, or one that affects more than 200,000 but for which there is no reasonable expectation that a treatment can be developed that would be profitable.
  • Orphan drug: a drug developed specifically to treat an orphan disease.
  • Qualified expenses: clinical testing costs for the drug that meet the statutory requirements (clinical trial costs are the primary category targeted by the credit).

How the credit works

  • The credit is calculated as a percentage of qualified clinical testing expenses incurred in the development of an orphan drug. Since 2018, this percentage has been 25%.
  • The credit aims to reduce net development costs for sponsors, improving the economic feasibility of developing therapies for small patient populations.

History and recent changes

  • The Orphan Drug Act was enacted in 1983 after recognition that market forces alone were insufficient to motivate development of therapies for very rare diseases.
  • From 1983 until 2017, the orphan drug tax credit covered 50% of qualified clinical testing costs for certain drugs; a tax law change effective in 2018 reduced that credit to 25%.
  • The change was controversial and drew opposition from patient advocacy groups that feared it would slow orphan drug development.

Impact and scope

  • Since the Orphan Drug Act’s passage, hundreds of orphan-designated products have been approved—enabling treatments for many rare diseases that previously lacked options.
  • Approximately half of approved orphan treatments are in oncology.
  • Rare diseases collectively affect a large number of people: an estimated 30 million in the U.S. and roughly 7,000 distinct rare conditions, of which a large share still lack approved therapies.

Considerations

  • The orphan drug credit focuses on clinical testing expenses; other development costs may not qualify.
  • Sponsors must meet statutory and regulatory definitions and procedural requirements to claim the credit and to obtain orphan designation and related FDA incentives.
  • Policy and tax-law changes can alter the size or scope of the credit, affecting investment decisions.

Conclusion

The orphan drug credit is a targeted tax incentive intended to reduce the financial barriers to developing treatments for rare diseases. Alongside exclusivity periods and FDA fee incentives, the credit has helped spur approvals and increased attention to rare-disease drug development, although its exact value and scope have changed over time.