In this light, the Medical Device tax remains an important part of the health care reform legislation and is something that needs to be remembered and taken into consideration during planning.

Here are six things to know about the Medical Device tax.

1. What is the Medical Device tax?

The Health Care and Education Reconciliation Act 2010 (P.L. 111-152), in conjunction with the Affordable Care Act, created section 4191 of Chapter 32, Subtitle D of the Internal Revenue Code. 

This section, specifically section 4191(a), imposes an excise tax on manufacturers or importers of taxable medical devices. It should be noted that the Manufacturers and Retailers Excise Tax Regulations, section 48.0-2(a)(4)(i) defines a manufacturer to include a "producer" and an "importer."

A manufacturer generally is the person who produces a taxable medical device either from scrap, salvage or junk material, or from new or raw material, by processing, manipulating or changing the form of a device or by combining or assembling two or more devices. 

An importer of a taxable medical device is the person who brings the device into the United States from a source outside the United States, or withdraws the device from a customs-bonded warehouse for sale or use in the United States.

This law applies only to manufacturers or importers of taxable medical devices, therefore, no action is required by individual consumers.

The law went into effect on sales after December 31, 2012 and levied a tax of 2.3 percent (0.23) on the sale price of any taxable medical device. 

As early as 2012, there has been great opposition to the tax, with members of Congress seeking to either delay the tax or to completely repeal the tax.  These efforts were not successful until the passage of the Consolidate Appropriations Act of 2016 which imposed the moratorium.

2. What is a taxable medical device?

In general, a taxable medical device is a device that is listed as a device with the Food and Drug Administration of the Federal Food, Drug, and Cosmetic Act (FFDCA) and 21 CFR part 807, unless the device falls within an exemption from the tax, such as the retail exemption. 

Under the terms of section 4191(b), a taxable medical device is any device (FFDCA sec. 201(h)) which is intended for humans.  However, in the FFDCA section 321(h), the term "medical device" has broad interpretation, allowing a medical device to range from tongue depressors to artificially-created hearts. 

The Treasury Department has rejected any attempts by some to narrow the scope of the definition by limiting the "taxable medical device" to devices that could be used exclusively by humans or devices that could be used exclusively for a medical purpose. 

In this regard, devices such as infusion pumps that can be used both by doctors who are treating human beings as well as by veterinarians are included as "taxable medical devices." 

This same principle applies to latex gloves–which clearly have both medical and non-medical uses.

3. What are convenience kits?

A "convenience kit" has been defined (within the meaning of section 201(h) Federal Food, Drug, and Cosmetic Act) as "two or more different medical devices packaged together for the convenience of the user where they are intended to remain packaged together and not replaced, substituted, repackaged, sterilized, or otherwise processed or modified before the devices are used by an end user." 

A convenience kit may contain a combination of devices within the meaning of section 201(h) of the FFDCA and other articles.

Convenience kits that are listed with the FDA under section 510(j) of the FFDCA and 21 CFR Part 807 are "taxable medical devices" under the regulations unless they fall within an exemption under § 4191(b) or § 48.4191-2(b) of the regulations.

IRS Notice 2012-77 provides interim guidance on the taxable treatment of these convenience kits. 

Under the interim guidance, a taxable medical device that goes into a domestically-produced convenience kit will be subject to tax upon its sale by the manufacturer or importer, but the sale of the convenience kit by the kit producer will not be subject to tax. Special rules apply to imported kits. 

Imported convenience kits

Until the IRS and the Treasury Department issue further guidance, tax is imposed under § 4191 on the sale by an importer of a convenience kit that is a taxable medical device under § 4191 of the Code and § 48.4191-2(b), but only on that portion of the importer's sale price of the convenience kit that is properly allocable to the individual taxable medical devices included in the convenience kit.

4. What are some exemptions to the excise tax?

There are specific statutory exemptions and retail exemptions. Let's look at them now.

Specific Statutory Exemptions

Section 4191(b)(2)(a), (b) and (c) exempts several specific devices from the tax, including eyeglasses, contact lenses, and hearing aids.

Retail Exemption

Section 4191(b)(2)(d) exempts "any medical device determined by the Secretary to be a type that is generally purchased by the general public at retail for individual use. 

This definition, admittedly broad, has been clarified some by Treasury Regulation 48.4191-2 which clearly establishes a two-part test to determine if the exception under Section 4191(b)(2)(d) exists. 

The first threshold requires determination of whether the device is "regularly available for purchase and use by individual consumers who are not medical professionals". The second threshold is that the device is designed as such that "it is not primarily intended for use in a medical institution, office, or by a medical professional." 

Neither part is specifically controlling as to determine whether the retail exemption is met, rather the test is satisfied by looking at "all relevant facts and circumstances."

In order to identify if the retail exemption is met, a number of factors need to be reviewed, including these:

• The ability of  consumers to purchase the device through a drug store or other retailer that primarily sells a particular device;

• The need of a consumer to seek help from a medical professional to use the device safely and effectively; and

• Whether the device has been classified by the Food and Drug Administration as a "physical medicine device" for human use.

Treasury Regulation 48-4191-2(b) also provides a list of factors to help determine whether a device is designed primarily for use in a medical institution or office or by a medical professional.  These factors include:

• Whether the device must be implanted, inserted, operated or administered by a medical professional

• The cost of obtaining and using the device

• How the device has been classified by the Food and Drug Administration; and

• Whether the device is one for which payment is available "exclusively on a rental basis" and is an item requiring "frequent and substantial servicing" as the terms are defined under the rules of Part B of Medicare.

The regulation points out that the packaging and labeling of a device and the paperwork and documents submitted for approval of the device are not relevant in determining whether it is part of the retail exemption. 

This prevents a manufacturer from avoiding the tax by simply marking the device for "retail use only."

Examples of the Retail Exemption

The regulations include over a dozen examples that apply the "totality of the facts and circumstances test" to several types of medical devices. 

The examples conclude that items such as non-sterile absorbent tipped applicators, adhesive bandages, snake bite suction kits, denture adhesives, mechanical and powered wheelchairs, portable oxygen concentrators, pregnancy test kits, and therapeutic alternating current powered adjustable home use beds are some devices that fall within the retail exemption.

Based on the totality of the circumstances presented in the examples, the examples also conclude that mobile x-ray systems, nonabsorbable silk sutures, powered flotation therapy beds, and nuclear magnetic resonance imaging systems are not devices that fall within the retail exemption.

Retail exemption "safe harbor"

The regulations identify certain categories of devices that qualify for the retail exemption so that manufacturers and importers do not have to apply the facts and circumstances test.

Those categories are set forth in a safe harbor provision in § 48.4191-2(b)(2)(iii) of the regulations.  These are intended to provide a "greater certainty" regarding which items are subject to the retail exemption. 

The safe harbor encompasses items such as pregnancy test kits as well as some things that qualify as durable medical equipment, prosthetics, orthotics, and supplies available through purchase under Medicare Part B.

Tax-free sales of taxable medical devices

In some circumstances, a  manufacturer or importer of a taxable medical device may sell a taxable medical device tax-free for use by the purchaser for further manufacture (or for resale by the purchaser to a second purchaser for further manufacture), or for export or for resale for export. 

To make a tax-free sale for further manufacture or export, both parties to the sale must be registered with the Internal Revenue Service, using Form 637 "Application for Registration for Certain Excise Tax Activities."

5. What are rules around reporting and filing?

As stated, the tax is 2.3 percent of the sale price of the taxable medical device. 

IRS Publication 510, Excise Taxes, Chapter 5, page 34 and well as IRS Notice 2012-77 can provide specific information on determination of sales price.  Internal Revenue Code section 4216 provides rules for determining sale price. 

Notice 2012-77 provides guidance in the creation of a "constructive sales price" accounting for the uniqueness of the market of medical devices.  The notice provides specific rules to determine sale price based on the distribution chain for the product.

The Medical Device tax is a "manufacturers' excise tax."  The form used for reporting excise taxes to the IRS is Form 720, the Quarterly Federal Excise Tax Return. 

Generally, the manufacturer or importer of a taxable medical device is responsible for filing Form 720 as well as submitting payment to the Internal Revenue Service.

Internal Revenue Publication 510 provides addition information on filing, deposits and payments, specifically in Chapters 11 and 12.

Form 720 is filed on a quarterly basis. Quarterly return due dates are as follows:

• First quarter (January, February and March)  – due April 30

• Second quarter( April, May and June) – due July 31

• Third quarter (July, August and September) – due October 31

• Fourth quarter (October, November and December) – due January 31

Semi-monthly deposits will generally be required if tax liability exceeds $2,500 for the quarter. 

6. The future of the Medical Device tax

Clearly, the tax is "on hold" for 2016 and 2017, but it is not dead.  Without further action, it will automatically revive at the start of 2018.

There are arguments both for and against the tax.  Those arguing to keep the Medical Device tax point out several important factors:

• Revenue expectations:  The Medical Device tax is expected to bring in $38 billion over a ten-year period from 2013 to 2013.

• Part of a Comprehensive Plan:  The Medical Device tax is a component of the broader health care reform package and the plan to fund it. Concerns have been raised that if questions are raised regarding the justification of the Medical Device tax, other taxes that are part of PPACA would be ripe for elimination as well.

• In addition to the Medical Device tax, PPACA is funded by the Cadillac tax (expected revenues of $110 billion over ten years), taxes on drug manufacturers and importers (expected revenues of $34.2 billion over ten years), fees on providers of health insurance (expected revenue of $101.7 billion over ten years).

• Proper to tax Industries that benefit from health care:  It has been argued that the expansion of health care coverage to additional millions will benefit this market, and because of that, they should contribute to the success of health care  reform.

Arguments against the Medical Device Tax include these:

• Validity of the use of an excise tax:  Excise taxes are generally used to either deter behavior, such as taxing tobacco or alcohol or to obtain funds for distribution purposes for related activities, such as gasoline taxes being used for the building and maintaining of bridges and roads.  It could be argued that both the excise tax revenue from the Medical Device Tax and the Cadillac taxes could be used for health care, but a problem exists in that the revenue from the Medical Device tax is not earmarked, but goes to the general fund.

• Administrative costs can be significant.

• Compliance costs can be even more significant.  As mentioned in this article, determination of sale price can be complicated and difficult to audit.

• Effect on the economy and the industry:  It has been argued that the tax has resulted in the loss of tens of thousands of jobs in the medical device industry and the money collected from the tax is money that could have been used for new research and development.   The validity of this argument is not yet determined but it is one of the most vocal arguments made by the industry.

This issue promises to continue to be a subject of disagreement and continued debate.  It currently slumbers in a moratorium, but the health care industry and health care reform will be affected by whether it wakens in 2018.