The Internal Revenue Service (IRS) released final regulations and other guidance on the excise tax applicable to the sale of certain medical devices under the Affordable Care Act. Beginning January 1, 2013, a tax of 2.3 percent is imposed on the sale, use, lease, or license of all medical devices by manufacturers and importers.
In the guidance, the IRS has confirmed that most types of medical devices intended for humans are subject to the excise tax. Medical devices purchased by the general public at retail businesses for individual use and the sales of taxable medical devices for further manufacture or export are not subject to the tax. The IRS also issued interim guidance and requested comments on methods for determining the constructive sales price of a medical device, the taxation of donated medical devices, whether the licensing of medical devices (such as software) is taxable, and the tax treatment of medical convenience kits.
Taxable Medical Devices
As proposed, the IRS confirmed that the tax applies to all devices listed with the Food and Drug Administration (FDA) under the applicable section of the Federal Food, Drug and Cosmetic Act (FD&C Act) and the applicable federal regulations, as well as devices that should have been listed with the FDA, including:
- Biologics (not including any biologics that are not listed with the FDA under the FD&C Act, but are regulated by the Center for Biologics Evaluation and Research, such as those listed under regulations that apply to manufacturers of human blood and blood products)
- Sterilization process indicators, software, and containers used to hold or transport medical products and specimens
- Devices that are not used exclusively for humans (i.e., also intended for veterinary use)
- Devices that are not sold exclusively for medical use (i.e., devices not intended solely for medical purposes)
- Humanitarian use devices
- Combined products (therapeutic and diagnostic products that combine drugs, devices, and/or biologic products)
Kits produced by hospitals and medical institutions are exempt from the FDA registration and listing requirements and are not subject to the tax, but sales of the individual medical devices in the kits by the manufacturers to the kit producers are subject to the tax.
Exception for Medical Devices Sold at Retail
The tax does not apply to medical devices that are regularly available for purchase by individual consumers, in person, over the telephone or over the Internet through retail businesses, and that are not primarily intended for use by medical professionals or facilities. These devices include eyeglasses, contact lenses, and hearing aids. The regulations adopt a “facts and circumstances” approach to determining whether a medical device falls within the retail exception, and they include a non-exclusive list of factors to determine whether a device is regularly available for purchase by consumers who are not medical professionals.
The regulations also include a safe harbor provision that identifies certain categories of medical devices that meet the retail exception, including: over-the-counter home use lab tests; durable medical equipment and prosthetic and orthotic devices for which payment is available under Medicare Part B and do not require implantation or insertion by a medical professional; parenteral and enteral nutrients, equipment, and supplies; customized items as described in regulations for devices covered by Medicare Part B payments, such as orthotics; therapeutic shoes; and certain supplies for the effective use of durable medical equipment. Examples illustrating the application of the rule are included in the final regulation.
Other Exceptions from Tax
In addition to those medical devices that are not listed with the FDA, the final regulations provide a few other exceptions from the tax:
- The sale of software that is a component of a listed medical device and updates to component software, which are not required to be separately listed
- Donations of listed devices to an eligible donor
Additionally, in the event listed software is sold together with a service or maintenance contract, the tax only applies to that portion of the sales price allocated to the listed software.
The regulations do not provide any transition relief for contracts entered into before January 1, 2013, unless the contract was entered into before March 30, 2010. Payments made on or after January 1, 2013, pursuant to a written contract for the lease, installment sale, or sale on credit of a taxable medical device that were in effect prior to March 30, 2010, are not subject to the tax unless the contract was materially modified to change the product being sold or leased, or the payment terms.
Determining the Sale Price
The IRS announced interim rules on determining the constructive sale price in acknowledgement of the differing distribution chains regularly employed in the medical device industry. The rules set a range of percentages (depending on the distribution chain) based on the lowest actual selling price as the constructive sale price for purposes of the tax if the purchaser is a reseller other than an independent wholesale distributor. A taxpayer may use the rules, the actual sale price, or its own determination of the fair market value to calculate its tax liability. A manufacturer may take into account a rebate in determining the sale price, but only to the extent that the rebate is made before the close of the quarter during which the sale associated with the rebate is made.
The medical device excise tax is reported quarterly on Form 720, and to make tax-free sales, the manufacturer must register using Form 637. Each business unit with a separate tax identification number (even a disregarded entity) must file its own return or registration form and may not consolidate the tax reporting with affiliated corporations. Semi-monthly deposits of the tax are required unless the net tax liability does not exceed $2,500 for the quarter.