What Is the Orphan Drug Credit?

The orphan drug credit is a federal tax credit available to businesses, not individuals, that gives pharmaceutical companies incentives to develop medications and treatments for rare diseases that do not affect enough people for the company to be able to make a profit on the sales of those treatments to the patient population.

Key Takeaways

  • The orphan drug tax credit gives companies researching cures for rare diseases a seven-year window of tax reductions and the exclusive right to develop a cure for a specific condition.
  • The credit is part of the Orphan Drug Act, which was designed to encourage companies to develop drugs for rare diseases.
  • Orphan drug status can be granted for new drugs, already approved drugs, or drugs that are already on the market.
  • However, if the drug is already approved, the sponsor must submit a plausible hypothesis on how the drug is clinically superior to previous drugs or undeveloped drugs.

Understanding the Orphan Drug Credit

The orphan drug credit is a credit available to pharmaceutical companies to create financial incentives to develop medications and treatments for rare diseases that affect small populations. This credit can be claimed by the pharmaceutical company whether testing to develop the treatments is performed by the company itself or contracted out to third parties. With some exceptions, testing must occur in the United States. Orphan drugs are drugs developed to treat orphan diseases, which is the group term for extremely rare medical conditions such as Huntington's Disease, ALS, and Tourette Syndrome, among others.

Despite being rare conditions individually, orphan diseases affect a large number of people. Although there are almost 30 million people suffering from orphan diseases in the United States, there are only approved treatments for four percent of those diseases. This means that patients with 96 percent of orphan diseases have no good treatment options. The orphan drug tax credit is an effort to encourage the development of treatments for these diseases to give relief to the patients affected by them. Without these tax credits, pharmaceutical companies would be forced to charge prices for the treatments that are so high that the affected patients could never afford them, which would defeat the purpose of developing these treatments in the first place. The orphan drug tax credit bridges this gap and helps the companies develop the treatments while allowing them to be reasonably-enough priced that the people who need them can afford them.

History of the Orphan Drug Credit

In 1982, the U.S. Food and Drug Administration (FDA) recognized the lack of incentive for pharmaceutical companies to develop cures for rare diseases. From this realization, the Orphan Drug Act of 1983 was born. The plan was to target diseases affecting fewer than 200,000 people in the U.S. 

Before the Orphan Drug Act was passed, pharmaceutical companies and medical researchers were unable and unwilling to invest in treatments for extremely rare diseases, because they knew developing these treatments would never pay for themselves. There simply aren't enough patients of each orphan disease to be able to recoup their expenses, let alone make a profit. Clinical trials cost thousands of dollars per patient even when the researchers could find enough patients to run these trials. They were unable to develop these treatments without a sponsor for the treatment development process, and many treatments sat waiting for a sponsor.

Between 1983 and 2018, the orphan drug tax credit gave a credit of 50 percent of the clinical testing costs for drugs being tested under section 505(i) of the Federal Food, Drug and Cosmetic Act. Part of the overhaul of the tax code conducted in 2017 during the Trump administration reduced the amount of the orphan drug tax credit from 50 percent to 25 percent of qualified clinical testing expenses beginning in 2018. This was seen as harmful by the National Organization for Rare Disorders and many other advocacy groups.