Obamacare means new tax, new challenges

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Posted: Sunday, January 20, 2013 12:00 am

A lot of taxpayers dodged tax increases at the beginning of the year, but the industry that makes medical devices did not.

As of Jan. 1, companies such as La Vista manufacturer Streck Inc. are paying a 2.3 percent excise tax as part of funding the federal health care law. It's one of a handful of new taxes kicking in this year because of the 2010 law aimed at extending health care insurance benefits to millions more Americans.

Industry leaders and even some Democrats in Congress who voted for the health care law are concerned that the medical device tax will stymie innovation and cost the U.S. jobs and its global leadership position in medical technology. More than 400,000 people are directly employed by the industry, which also is responsible for 2 million high-skilled manufacturing jobs.

While the medical device manufacturer is responsible for reporting and paying the tax, industry leaders say it could be indirectly passed on to the manufacturer's customers — usually hospitals — that will in turn pass it on to patients.

“It's a sizable new expense we've never had to consider or deal with in the past,” said Mike Morgan, CFO at Streck.

Mike Morgan

For this year's expected $80 million in sales, Streck will pay more than $1 million for the medical device tax. That's in addition to normal corporate income taxes.

Most concerning to companies, Morgan said, is that the new tax applies to a company's revenue, not profit.

Say, for example, that for every $1 million in sales Streck makes, the company earns a profit of about 20 percent, or $200,000. If the device tax was applied to the company's profit, Streck would owe $4,600 to the Internal Revenue Service. But the device tax is applied to the company's revenue, which means Streck owes $23,000 on every $1 million in sales.

The government's definition of a medical device is not one that is commonly purchased at a neighborhood drugstore, but one that is regulated by the Food and Drug Administration and is an item used on or inside a patient.

Common examples are pacemakers, replacement joints such as hips and knees and magnetic resonance imaging (MRI) parts. A Streck example? The clinical kits used for blood tests that it makes at its plant near 108th and Harrison Streets.

Morgan said Streck is a financially sound company and can absorb the cost for now, but other device manufacturers aren't in the same position.

Sixty-two percent of 81 medical device manufacturing companies surveyed told the Advanced Medical Technology Association, an industry trade group, that they expect to lay off workers or reduce hiring to offset the cost of the tax. The group estimated the device tax would wipe out up to 43,000 jobs nationally.

Already, device manufacturer Stryker announced in December plans to close its Orchard Park, N.Y., facility that employs 96 people and to cut about 1,000 employees globally. Diagnostic equipment manufacturer Welch Allyn, based in Skaneateles Falls, N.Y., says it will cut 275 employees over the next three years.

The potential for layoffs caught the attention of retiring Nebraska Sen. Ben Nelson, who was among 18 Democratic senators on Dec. 4 to sign a letter to Senate Majority Leader Harry Reid that requested delaying the implementation of the medical device tax.

“In an environment focused on increasing exports,” the letter read, “promoting small businesses and growing high-tech manufacturing jobs for the future, we must do all we can to ensure that our country maintains its global leadership position in the medical technology industry and keeps good jobs here at home.”

The delay was not included in last-minute “fiscal cliff” legislation, and Capitol observers say industry lobbyists face a steep climb getting a repeal or having the issue addressed as part of tax reform.

In Nebraska, the medical equipment and supplies manufacturing industry isn't a huge employer — about 4,000 people, according to Nebraska Department of Labor data from the second quarter of 2012 — but it is an area targeted for growth.

Nebraska officials have funneled millions of dollars into bolstering innovation in recent years, said Michael Dixon, CEO of UNeMed Corp., the technology licensing arm of the University of Nebraska Medical Center. Through that, UNeMED has overseen the development of a number of products and companies that have produced high-skilled, well-paying manufacturing jobs.

The development of medical devices also was planned into the future Omaha cancer research center and Lincoln Innovation Campus, where lab spaces will be dedicated to help incubate such devices.

To stifle innovation in medical device making now would be a massive disappointment, Dixon said.

“Essentially what (the tax) is going to do is increase the risk for anyone starting a company because it's going to take a lot of potential revenue out of it. You're left with a lot of risk and less revenue,” he said. Dixon also is concerned it will hurt UNeMed's ability to develop technology because investors won't want to put money into an industry facing rising costs.

Not everyone agrees the device tax is going to be a burden for patients, doctors or the manufacturers themselves.

Dr. Donald Frey

Dr. Donald Frey, vice president for health services at Creighton University, said the point of the health care law was to insure more Americans, and Congress and the White House needed to find a way to help pay for it. Taxing the device manufacturers' revenue instead of their profit means the government will bring in more money — up to $29 billion over the next 10 years, according to the congressional Joint Committee on Taxation.

In comparison, the committee also estimated that the tax to help finance Medicare changes through the ACA, which also went into effect Jan. 1, will bring in about $210.2 billion over the next decade.

Frey said the rationale behind the device tax wasn't to kill the industry, but to offset a significant windfall that medical device manufacturing companies are likely to receive when an estimated 20 million more people have health insurance. The Congressional Budget Office projects that 32 million more people will have insurance by 2019.

Before the Affordable Care Act, Frey said, uninsured people would show up at an emergency room and forgo treatments that required a medical device because of their high costs. Medical device manufacturers missed out on sales. Insurance coverage should lead to more sales.

“When you look at the number of people added to the insured,” Frey said, “these (medical device manufacturing) companies are going to make a lot more money.”

Manufacturers question that assumption, saying a lot of those newly insured will be young people, not candidates for knee replacements.

Morgan said he believes it's unfair for the device tax to apply to Streck's products starting this year when the Affordable Care Act isn't set to start covering more people until 2014. And even though millions more people will have insurance starting next year, that doesn't necessarily mean Streck's phone will be ringing off the hook with orders.

“Our customers are still the labs and the hospitals,” he said. “We're once-removed from the benefits.”

Frey said it's understandable manufacturers are frustrated that the timing isn't aligned. “But in all honestly,” he said, “in the grand scheme, I'm not sure how much difference one year will make.”

Some entrepreneurs fear that one year could make all the difference for startup companies.

Randy Jones

Local inventor Randy Jones has a couple of years under his belt as president of Resonance Innovations LLC, which creates parts for MRI machines as ScanMed just off 144th Street and Interstate 80. He said his company, with about 25 employees, is just exiting the startup mode and entering a growth mode, and he already sees how the tax will affect him and companies just starting out.

“It's another hurdle,” he said. “Those companies that are in their startup mode, they have kind of the same problem companies that are in the low-margin mode have: A lack of capital.”

Even more, Jones isn't clear on how the tax will affect two large contracts he landed before the end of December that he expected would bring in some $4 million to his company. The contracts are with larger manufacturers that have plans to label Jones' devices privately and resell them for a greater price to hospitals.

So in this case, where Jones plays a dual role as manufacturer and wholesaler to another manufacturer, he wants to know who's responsible for the device tax. Generally, the device tax guidelines say the manufacturer or producer is responsible.

“So the person that's getting penalized is the person that's inventing and manufacturing — the resellers are not (getting penalized),” he said. “I think it's completely unfair and just overboard. It's not a nearly specified-enough tax, and it's a real kick in the pants to anybody who wants to be the manufacturer.”

Both Jones and Morgan called the device tax a “de-stimulus” during a time it's common to hear politicians promise to bring back “high-paying manufacturing jobs” to the United States.

“I could import from China and resell,” Jones said, “but that's not the business I'm in, and that's not what I'm in the business to do.”

Contact the writer:

402-444-1192, emily.nohr@owh.comto

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