IRS Form 8820: Orphan Drug Credit Election and Carryovers

IRS Form 8820 is how a taxpayer calculates and claims the Orphan Drug Credit, worth 25% of qualified clinical testing expenses for a drug that treats a rare disease or condition. You attach the form to your annual income tax return, report your qualifying expenses, decide whether to elect the reduced credit under Section 280C, and identify each orphan drug by its FDA designation. The instructions below walk through what belongs on each line and the decisions that drive the numbers.

Who Can File Form 8820

Three conditions must all be met before you put anything on the form.

The drug or biological product needs a formal orphan drug designation from the FDA under Section 526 of the Federal Food, Drug, and Cosmetic Act.¹ The sponsor has to apply for that designation and show the drug meets the rare-disease criteria; FDA regulations at 21 CFR Part 316 govern the process.² A “rare disease or condition” means one affecting fewer than 200,000 people in the United States, or one affecting more than 200,000 people when there is no reasonable expectation that development and marketing costs will be recovered from U.S. sales.³

Only expenses inside a specific window qualify. That window opens on the date the FDA grants the orphan designation and closes on the date the FDA approves the drug for patient use, or for biological products the date a license issues under the Public Health Service Act.³ Expenses before designation or after approval do not count.

The clinical testing must be conducted by or on behalf of the taxpayer who holds the FDA designation. A company that funds someone else’s designated drug cannot claim the credit; designation holder and credit claimant have to be the same entity.³

What Goes on Line 1: Qualified Clinical Testing Expenses

Line 1 asks for total qualified clinical testing expenses (QCTEs) paid or incurred during the tax year. QCTEs use the same categories as the Section 41 research credit with two modifications.³

The categories that count are wages for employees directly performing clinical testing, the cost of supplies consumed in testing, and amounts paid for the use of equipment or other personal property. These have to relate to human clinical testing; preclinical lab work and animal studies do not qualify.

The first modification is favorable. Contract research expenses count at 100% of the amount paid, not the 65% figure that applies under the general research credit.⁴ Sponsors that outsource trials to contract research organizations get the full cost into Line 1.

The second modification is restrictive. Any expenses covered by a grant, contract, or payment from another person or a government entity are excluded from QCTEs.³ If a government grant reimburses 40% of a trial’s costs, only the unreimbursed 60% belongs on Line 1.

Foreign Testing

Trials conducted outside the United States can count, but only when the U.S. testing population is insufficient for the trial and the foreign testing is conducted either by a U.S. person or by someone unrelated to the designation holder.³ Both conditions have to be met.

Line 2a: Full Credit or Reduced Credit Election

This is the decision that most affects your final tax outcome. Line 2a asks whether you are electing the reduced credit under Section 280C(b)(3).

If you check “No,” you multiply Line 1 by 25% and claim the full credit. There is a cost. You must reduce your otherwise-allowable deduction for those same clinical testing expenses by the credit amount, or, if you capitalized the expenses, reduce the amount charged to your capital account by that amount.⁵ You also attach a statement to the return identifying which deduction lines you reduced and by how much.

If you check “Yes,” you multiply Line 1 by 19.75% instead and keep the full expense deduction.⁴ The 19.75% rate is 25% reduced by the product of 25% and the 21% corporate tax rate.⁵

For a C corporation at the flat 21% rate, the two paths produce the same net federal tax benefit. The reduced election skips the deduction adjustment and the attached statement. The choice changes when state tax rates, net operating losses, or other factors alter the effective value of the deduction.

The election is made on Form 8820 filed with the original timely return, including extensions, and is irrevocable for that year.⁴

Lines 2b Through 6 and Part II

Line 2b handles a narrow overlap. If any wages used on Line 2a were also used to calculate the employer differential wage payment credit on Form 8932, enter the overlapping amount here. Line 2c subtracts that overlap so the same wages do not generate two credits.

Line 3 captures orphan drug credit passed through from partnerships, S corporations, estates, or trusts. Line 4 is the total credit for the year.

Estates and trusts use Lines 5 and 6 to allocate the Line 4 credit between the entity and its beneficiaries in proportion to how income was distributed. Partnerships and S corporations do not use Lines 5 and 6; they report the Line 4 total on Schedule K for allocation to partners or shareholders.

Part II requires the generic name of each orphan drug, the FDA designation application number, and the date the drug received its orphan designation. If you have multiple qualifying drugs, attach additional Part II pages. Keep your FDA designation approval letters accessible; they support the entries here if the credit is examined.

Pass-Through Recipients

If your only source of the orphan drug credit is an allocation from a partnership, S corporation, estate, or trust, you do not file Form 8820 yourself. Report the allocated amount directly on Form 3800, General Business Credit, with your return.⁴ The entity that incurred the clinical testing expenses files Form 8820 and makes the reduced credit election.

Where the Form Attaches and Which Return

Form 8820 attaches to the taxpayer’s annual income tax return: Form 1120 for corporations, Form 1065 for partnerships, or Form 1041 for estates and trusts.⁶ The Line 4 total flows into Form 3800, where the credit joins the General Business Credit.

Using the Credit: Limits and Carryovers

The orphan drug credit is subject to the General Business Credit annual limitation. In any year, the total General Business Credit used cannot exceed net income tax minus the greater of tentative minimum tax or 25% of net regular tax liability above $25,000.⁷ The credit cannot push tax below the Alternative Minimum Tax threshold.

When the limit prevents full use in the current year, the unused portion carries back one year and forward up to 20 years.⁸ For sponsors with heavy clinical trial spending and modest current-year tax, most of the value shows up in the carryforward.

Coordination With the Section 41 Research Credit

Clinical testing expenses used to claim the orphan drug credit cannot also be used to calculate the Section 41 research credit for the same tax year.⁴ The same dollar of QCTE does not generate two credits.

There is one point that catches multi-year filers. Even though the expenses cannot count toward both credits in a single year, clinical testing expenses that also meet the Section 41(b) definition of qualified research expenses are still included when calculating base period research expenses for the research credit in later years.³ Leaving them out distorts the base and understates future research credits.

1
Food and Drug Administration. Designating an Orphan Product: Drugs and Biological Products
2
eCFR. 21 CFR Part 316 – Orphan Drugs
3
Office of the Law Revision Counsel. 26 USC 45C – Clinical Testing Expenses for Certain Drugs for Rare Diseases or Conditions
4
Internal Revenue Service. Form 8820 – Orphan Drug Credit
5
Office of the Law Revision Counsel. 26 USC 280C – Certain Expenses for Which Credits Are Allowable
6
Internal Revenue Service. About Form 8820, Orphan Drug Credit
7
Office of the Law Revision Counsel. 26 USC 38 – General Business Credit
8
Office of the Law Revision Counsel. 26 USC 39 – Carryback and Carryforward of Unused Credits