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by Bill Leary, CPA, Director, Tax Group
As part of the Patient Protection and Affordable Care Act, a new 2.3 percent federal excise tax on medical devices is now in effect for certain sales and payments made after Dec. 31, 2012. The tax will apply to a wide range of products, and the rules are highly controversial.
Though the rate of tax is small, it is not based on taxable income and could cost the industry as much as $29 billion over the next 10 years, which may not be absorbed by doctors, hospitals and health care facilities, and their consumers. Further, classifying devices under the rules is difficult because they link together esoteric Food and Drug Administration (FDA) and Internal Revenue Service (IRS) laws.
Tax payments – not estimates – for first quarterly returns for the tax is due to the IRS April 30, 2013, covering January, February and March 2013, regardless of whether the medical device business had a system in place to collect the excise tax.
For accounting purposes, the excise tax does not fall within the scope of ASC 740 (income taxes) since it is measured on a gross basis and not on income. Financial statement presentation will depend on the fact and circumstances.
A taxable medical device, under the tax rules, is any device intended for humans under § 201(h) of the Federal Food, Drug, and Cosmetic Act. If a product is labeled, promoted or used in a manner that falls under the Act, it may be subject to the tax. If a business has registered a product with the FDA, the excise tax may apply.
Dental and optical FDA-listed equipment may be taxable. The final regulations do not create a special rule for dental devices such as crowns, bridges and braces. Customized devices may be exempt if, based on the “totality of the facts and circumstances,” the device is of a type purchased by the general public at retail for individual use (see Retail Exemption below). A bright line test, relying on longstanding FDA classification rules, may have produced some draconian results, but it would have been easier for businesses to administer.
FDA-registered veterinary devices are not taxable medical devices, if they are intended for use exclusively in veterinary medicine.
Research-only medical devices and investigational devices are not subject to the tax. Humanitarian-Use Devices (HUDs) exempt by the FDA for treating individuals with “orphan” illnesses are generally taxable. (Congress neglected to include an express exemption for these devices.)
Certain health-related software is FDA regulated. Software not separately FDA-listed is exempt from the tax. For software sold with services, the tax attaches only to the sale of the listed products.
Medical products are sometimes packaged together into kits for convenience. Pending future guidance, no tax applies to the sale of domestically produced kits, but the taxable devices included in the kits will be taxed. A similar rule applies to imported kits. Combination products, with both a device component and a drug component, are taxable even if the branded prescription drug (BPD) fee applies.
Under the retail exemption, the tax does not apply to any medical device purchased at retail for individual use. The mere fact that a device is sold for use in a professional setting, however, is not determinative of a tax liability. All relevant facts and circumstances need to be considered.
A device is considered to be purchased by the general public at retail for individual use if the device meets two criteria:
As a result, a taxable medical device does not include eyeglasses, contact lenses and hearing aids. Prosthetic and orthotic devices not requiring implantation by a medical professional are eligible for the exception even if they require fittings or adjustments. Certain rental devices, such as power-driven wheel chairs, may qualify for the retail exemption under the facts and circumstances test. Portable oxygen concentrator falls within the retail exemption, and urinary bags are included in the safe harbor.
The tax applies to suppliers under tax rules regardless of FDA classification. Generally, a manufacturer is a business that produces a device through processing, manipulation or by combining two or more devices. An importer is a business that brings the device into the United States or withdraws the device from a bonded warehouse for domestic sale or use.
The excise tax applies to the first sale in the United States by a manufacturer (or its importation) and is based on the device’s sale price (less rebates) to distributors, retailers or service providers. Often, it is difficult for suppliers to segregate amount not subject to the excise tax from the total price of the product(e.g, non-taxable items, packaging, etc.).
Because the tax is triggered by the first U.S. sale, sales within a consolidated group can trigger a tax. Export sales are not subject to the tax. A manufacturer or importer of a taxable device may sell it for further manufacture or for export tax-free; however, both parties to the sale must be registered with the IRS.
The lease of a taxable article by the manufacturer is considered a sale. Until further guidance is issued, the IRS will treat a license of a taxable medical device as a lease of the device.
The donation of a taxable medical device by a manufacturer to a § 170(c) tax deductible charity will not trigger the tax unless the article is sold by the charity.
If the manufacturer of a taxable article uses it for other purposes, the manufacturer may be liable for tax. However, if a taxable article is used in manufacturer testing, the device is not a taxable.
In conclusion, if you are treated as a manufacturer or importer of FDA medical devices, the applicability of excise tax needs to be considered, and Doeren Mayhew can help you evaluate the implications for your business. For more information, contact our CPAs in Troy, Mich., or Houston, Texas. If you are interested in receiving our upcoming in-depth e-paper on this topic, email us here.
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