How to get through medical device excise tax compliance reviews quickly and with as little disruption to your business as possible.
By Mitchell Kopelman and Ori Epstein, Habif, Arogeti & Wynne
When you think of a medical device company, a software company is probably not the first thing to come to mind. With the myriad advances in technology, however, it is becoming more and more common for software companies to fall under the medical device umbrella. This becomes more perturbing if it subjects your product to the medical device tax. So it may seem strange to hear that a developer of picture archiving and communications system (PACS) software had to register and pay the medical device tax. If it seems strange to you, imagine how the IRS must have viewed the registration!
The PACS developer received a letter that it had been selected for a compliance review by the IRS. When the company received notice, it was unsure of what to expect. Was this an audit or something less severe? This scenario is familiar to healthcare IT companies across the country and is, most likely, at least partially to blame for some of the recent heated discussion about companies being audited for the medical device tax.
The fact is the letter was not a notification of an IRS audit. Rather, the IRS was conducting a medical device excise tax compliance review as a standard part of the process when a firm registers with the IRS as a medical device company.
Why all the attention from the IRS? Simply put, the IRS has been burned before. Many years ago after implementing a fuel excise tax, firms figured out how to take advantage of the system by setting up fake companies. A partial reason for a compliance review is simply to make sure a business is real.
With more knowledge and clear insights into what happens during a compliance review, healthcare IT companies can better prepare themselves and eliminate some of the stress of meeting with the IRS.
Below are the three things you need to know now to go through the compliance process quickly and with little disruption to your business:
1. Your documents will be requested. Though the documentation requested by the IRS may vary from company to company, in general the IRS likely will request audited financial statements, tax returns, and a narrative of business operations. The reasoning is two-fold: 1) to fully understand your business and confirm that you filed your previous year tax returns and 2) to avoid harassing taxpayers by, for example, selecting them for a compliance review and then selecting them for an income tax audit several months later. And if you’re selling your medical device into another country, be sure to have the correct documentation available to prove that your device did, in fact, leave the country. In the case of this PACS developer, providing an agent with acceptable documentation for overseas sales of an intangible medical device product, like software, proves to be more complicated. The IRS agent in this specific case informed us that companies selling intangible products should keep purchase orders, customer acceptance documents, and invoices on hand to prove that the software was received overseas.
2. You will be interviewed. During the interview portion of the compliance review, the IRS agent asked questions about business activities, the product, the owners and their roles within the business, and research and development activity. Some of these questions are to better understand the business, others are purely for data mining purposes, and some may be used to pinpoint areas that could be audited.
3. Your facility will be toured. A walk-through of your facility will be conducted during the IRS audit to ensure that your company is a real operating business. For our specific client, a software company, the tour was unlike anything the IRS agent had ever experienced. The agent was use to visiting facilities with full manufacturing operations rather than a quiet office where software was being developed.
While an IRS compliance review doesn’t cost a dime, medtech firms can save themselves valuable time by prepping for the meeting and having all financial records readily available during the review.
We recommend coordinating your preparation efforts with your CPA and scheduling the compliance review for a time when one of them can attend the meeting. Having your CPA by your side will ensure that all questions about the medical device excise tax can be accurately answered and addressed.
It’s important to note that every compliance review will be different, but with these insights into the overall process you can be better prepared if you receive a compliance review notice.
Mitchell Kopelman is partner-in-charge of the technology and biosciences group at Habif, Arogeti & Wynne, LLP. Reach him at email@example.com.
Ori Epstein is senior manager in Habif, Arogeti & Wynne’s technology and biosciences group. Reach him at firstname.lastname@example.org.