Colorado innovators weigh impact of contested tax

Although health-reform and fiscal-cliff fallout continues its scattered rain on all Colorado businesses, one large chunk has landed squarely in the front yards of the state’s medical-device companies. Now, with the ink barely dry on the first quarterly IRS payments for a 2.3-percent excise tax that took effect Jan. 1, these high-tech manufacturers are warning that a negative economic rumble could follow.

In 2010, faced with paying for President Obama’s $1 trillion Affordable Care Act, lawmakers approved the tax, expected to raise as much as $29 billion in the next 10 years from the $100-billion-plus medical-device industry. The tax made it through the end-of-year fiscal-cliff congressional session intact, but as ColoradoBiz went to press in mid-February, bipartisan bills calling for repeal of the medical-device tax had been introduced in both the U.S. House and the Senate. At stake, according to those in the field, are thousands of jobs and America’s leading edge in the medical-device marketplace.

“I am absolutely worried,” said April Giles, president and CEO of the Colorado BioScience Association, which has more than 350 members. “I’m worried for our small businesses, because it really limits their ability to get their product out into the market in a way that they can be successful and reinvest those dollars back into innovation.” The excise tax is levied on total revenue of all medical-device companies, regardless of size or profits.

Medical-device companies, responsible for everything from MRIs to hip replacements, are significant players in the national and state economy, working to improve patient care. Colorado employs 27,000 people in the bioscience industry, creating 122,000 direct and indirect jobs. That translates into about $10 billion in payroll, at an average annual salary of $82,000, Giles said. The medical-device sector makes up about half of the state’s bioscience industry and has grown by about 14 percent in the past three years, she said.

Many startup companies cannot afford the extra tax, as getting a product off the ground can take years before profits enter the picture, said Jack Wheeler, who has been in the state’s bioscience industry for 30 years and co-founded MicroPhage in Longmont in 2002. Wheeler has since left the company, currently working with TeraBAT, a Longmont company developing breathalyzer technology that could dramatically speed detection of life-threatening conditions, such as heart attacks.

“For companies with fewer than 50 employees (the majority of medical-device companies), a 2.3 percent tax on revenue could be anywhere from 40 to 60 percent of their income after tax,” Wheeler said. “This is what happened with MicroPhage. They were not making profits, but they still had to pay taxes on sales.” MicroPhage, which developed technology that could detect deadly bacterial infections in hours rather than days, filed for Chapter 11 protection on Dec. 28.

Although Giles suspects a less profound impact on the state’s larger companies, they will still feel the blow, she said. “Our small companies are really driving a lot of innovation right now, and big companies are looking for them to do that for acquisition or partnering. It really does hurt our competitive edge.”

Yet not everyone agrees. Paul Van de Water, senior fellow at the Center on Budget and Policy Priorities in Washington, D.C., downplayed the industry’s concerns. “I have to say that I suspect if the legislation had proposed to raise the exact same amount of money from a medical device tax on profits rather than on revenue, we’d still be hearing all of the same complaints,” Van de Water said. “Does Colorado have a sales tax? I suspect you do, and it’s probably well over 2.3 percent, and it hasn’t caused the demise of the industries affected yet.”

Nationwide cries that the tax is unfair are unfounded, Van de Water said, as it serves as only one of many required contributions from a range of industries to help pay for reform, he said, citing hospitals and insurance companies as examples. In his research, Van de Water found many device manufacturers say that if a product creates a demand, a 2.3-percent cost increase would not have an appreciable effect on their market. The same holds true for investment concerns, he said. “If they come up with something like what they call in the drug industry a “me-too drug,” something that’s only marginally better than what was there before, that’s not the kind of innovation we really care about.”

Even some in the industry consider the uproar inflated and say companies will just have to become more competitive in the new era of health-care reform. “I think it’s the cost of doing business,” said Kevin Smith, CEO of the Colorado Institute for Drug, Device and Diagnostic Development. Especially today, taxpayers are not going to have much sympathy for a lucrative industry being assessed a tax, Smith said. Sure, there will be some cutbacks or re-strategizing in the industry. “That’s because our shareholders demand that profit now. That’s the way capitalism and the free markets work. That’s reality.”

While most in the industry understand they need to contribute to change, Giles said, the question is: At what cost? Colorado companies are already reporting job cuts, investment woes and even troubles with vendors, which are critical to manufacturing-job success, Giles said. “Vendors are concerned about the ripple effect.” Sure, if a product is significant, a company will get it to market, she said. “But there might be fewer jobs behind it, and it will take longer to get there. Patient access to new technology will be slowed.”

Attracting seed money has been a struggle for TeraBAT because of the tax, and at a time when uncertainty has already dramatically affected venture capital in the industry, Wheeler said. “Companies are going to be reducing work force and attempting to increase prices, which is difficult in the medical community right now with the restrictions of cost containment.” He said 7,000 industry jobs nationwide have already been cut in 2012 in anticipation of the tax, citing a figure released by Reuters.

But Van de Water counters that it’s impossible to connect those job losses to the tax. He used an example of another charge the industry is making: that the tax is pushing jobs overseas. “We know that can’t be a result of the device tax, because the tax is structured in such a way that devices made overseas and sold here are subject to the tax, and devices made here and sold overseas are not subject to the tax. We also see device companies producing products that are in high demand adding jobs.”

Giles emphasized that her industry knows it should help pay for reform. “We are from the perspective that everyone is willing to put something on the table to get us there. But we need the Congress to stop playing wars and come to a consensus on what’s going to help this country get back on its feet.”

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Although both Colorado Sens. Mark Udall and Michael Bennet declined interviews, they said through their spokesmen that they were open to reevaluating the tax as part of a broader tax-reform package. Bennet spokesman Adam Bozzi said in an email: “The process should ensure that it is administered fairly for both large and small businesses and doesn’t hurt medical-device companies’ ability to hire and retain workers or dampen investment in startup companies.”

Tax or no tax, Smith has faith in the industry’s future. “The medical-device industry is a very resilient industry. I think that medical innovation comes about because smart people are trying to create a better patient outcome, and those smart people are going to continue to try to do that.”

Of 330 medical-device and diagnostics companies operating in a nine-county region in Colorado in 2012, nearly 68 percent employed fewer than 10 workers, while 2.4 percent employed 250 or more.
Metro Denver Economic Development Corp.

In 2006, the medical-device industry paid corporate income taxes of $3.1 billion on taxable income of $13.7 billion. The medical-device tax would add approximately $3 billion annually to the taxes paid by medical-device firms — a 100 percent increase.
The National Center for Policy Analysis

FISCAL CLIFF FALLOUT

No working American survived the Jan. 1 fiscal-cliff decisions by Congress unscathed, with those in higher income brackets taking a particularly powerful punch. Here’s a look at some of the changes in store at the tax table this year, along with brief commentary by accountant Lauren Long, who teaches in the Colorado State University College of Business, and accountant Fran Coet, founder of Coet and Coet in Westminster. Coet warned business owners that all of these last-minute tax changes are resulting in significant filing delays.

• Individuals and couples earning more than $400,000 and $450,000 respectively will see their rates increase 4.6 percent to a maximum rate of 39.6 percent.
• A new 3.8 percent Medicare tax on passive income, such as capital gains and dividends, will affect individuals with annual incomes above $400,000 and couples who earn more than $450,000.
• A new 0.9 percent Medicare tax on earned income, such as wages and self-employment income, will apply to individuals with earned income greater than $200,000 and couples with combined earned income of more than $250,000.
• Rates for dividends and capital gains will rise from 15 percent to 20 percent for individuals making more than $400,000 ($450,000 for joint returns).
• Higher-income taxpayers will also lose deduction options, as the Pease itemized-deduction phase-out and the personal-exemption phase-out were reinstated. The thresholds are $300,000 for married filing jointly, $275,000 for head of household, and $250,000 for single.

Long: “If you are in a higher-income bracket, it’s a big chunk of money.” Long advises business clients to consider shifting money and restructuring investments (i.e. buying municipal bonds) for cushion.
Coet: “You can see what that’s going to do to their budget.” Coet ran the math on a higher-income couple, finding that the changes could cost them nearly $17,000 more in taxes. And these are the people most likely to be business owners. “That could be a receptionist that isn’t going to get hired.”

All employees will see their paychecks reduced by 2 percent because the Social Security payroll tax deduction expired and was not renewed. (An income earner of $60,000 will take home $1,200 less this year, or minus $100 a month.)

Long: “I’m hearing from many small businesses that many of their employees are living paycheck to paycheck, so that’s kind of rough. Now they are going to ask for raises.”
Coet: “I think it’s going to have a large effect. If someone went out in December and bought a Toyota Corolla and has a $350 a month car payment, come the Feb. 1 car payment, they are going to come up short. People have commitments, and all of the sudden their paycheck shrank.”

The current $5.12 million exemption level for estate tax will remain in place, rather than be reduced to $1 million, and is now indexed for inflation, so the exemption for 2013 will be $5.25 million.

Long: “We had a lot of taxpayers giving away millions of dollars in assets, assuming the tax was going to change. I think a lot of people regret those gifts now. But there could be benefits of getting those assets out of your estate.”

Coet: “So small business owners looking at retirement or doing their estate planning will have stability for, I want to say, the foreseeable future.”

Increased allowable expensing of $250,000 will be extended for 2012 and 2013, and the increased 50 percent bonus depreciation rules for investment in new property and equipment will remain in place for possessions placed in service before the end of 2013.

Coet: “So if I buy a pickup truck to work in the field, I can take that purchase as equipment and expense the entire thing. They also left in qualified real-estate improvements, so I have a client who couldn’t afford a needed expansion for her beauty salon. Now if she wants to, she can expense the entire quarter-million-dollar improvement.”