Income Taxes
For the years ended December 31, 2017, 2016 and 2015, the Company did not record any federal or state income tax expense given its continued operating losses.
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act ("Tax Reform Act"). The legislation significantly changes U.S. tax law by, among other things, lowering corporate income tax rates, implementing a territorial tax systems and imposing a repatriation tax on deemed repatriated earnings of foreign subsidiaries. The Tax Reform Act permanently reduces the U.S. corporate income tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018.
The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. As a result of the reduction in the U.S. corporate income tax rate from the maximum 35% to 21% under the Tax Reform Act, the Company revalued its ending deferred tax assets and liabilities at December 31, 2017. This revaluation resulted in a reduction to the Company’s deferred tax asset of $55.6 million. Due to the Company's full valuation allowance, no provisional tax expense or benefit associated with the remeasurement was recognized in the Company's consolidated statement of income for the year ended December 31, 2017. However, the reduction of the U.S. federal corporate tax rate from the maximum 35% to 21% resulted in increases to the amounts reflected “Change in valuation allowance” and “Deferred rate change” captions for the year ended December 31, 2017 in the Company’s tax reconciliation table below compared to those amounts disclosed for the year ended December 31, 2016. The change in the U.S. federal corporate tax rate, which is effective January 1, 2018, is also reflected in the Company’s deferred tax table below.
The provision for income taxes for continuing operations was at rates different from the U.S. federal statutory income tax rate for the following reasons:
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| | | | | | | | |
| For the Year Ended December 31, |
| 2017 | | 2016 | | 2015 |
Statutory federal income tax rate | 34.0 | % | | 34.0 | % | | 34.0 | % |
State income taxes, net of federal benefit | 4.4 | % | | 5.0 | % | | 5.1 | % |
Research and development tax credits | 2.7 | % | | 1.3 | % | | 1.4 | % |
Orphan drug tax credits | 10.9 | % | | 10.5 | % | | — | % |
Deferred compensation | (0.8 | )% | | (0.5 | )% | | (0.4 | )% |
Interest expense | (0.5 | )% | | (0.4 | )% | | (0.5 | )% |
Deferred rate change | (104.4 | )% | | — | % | | — | % |
Permanent adjustments and other | (5.2 | )% | | (0.2 | )% | | 0.1 | % |
Change in valuation allowance | 58.9 | % | | (49.7 | )% | | (39.7 | )% |
Effective income tax rate | — |
| | — |
| | — |
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The principle components of the Company’s deferred tax assets at December 31, 2017 and 2016, respectively, are as follows:
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| | | | | | | |
| December 31, |
| 2017 | | 2016 |
Deferred Tax Assets: | | | |
NOL carryforwards | $ | 63,688 |
| | $ | 92,012 |
|
Research and development tax credit carryforwards | 15,340 |
| | 13,404 |
|
Orphan drug tax credit carryforwards | 15,580 |
| | 10,148 |
|
Depreciation and amortization | 11,663 |
| | 18,242 |
|
Capitalized research and development expenditures | 32,550 |
| | 35,848 |
|
Stock options | 4,948 |
| | 5,507 |
|
Accrued expenses and other | 155 |
| | 176 |
|
Total Gross Deferred Tax Asset | 143,924 |
| | 175,337 |
|
Valuation Allowance | (143,924 | ) | | (175,337 | ) |
Net Deferred Tax Asset | $ | — |
| | $ | — |
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The classification of the above deferred tax assets is as follows:
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| | | | | | | |
| December 31, |
| 2017 | | 2016 |
Deferred Tax Assets: | | | |
Current deferred tax assets | $ | — |
| | $ | — |
|
Non-current deferred tax assets | 143,924 |
| | 175,337 |
|
Valuation Allowance | (143,924 | ) | | (175,337 | ) |
Net Deferred Tax Asset | $ | — |
| | $ | — |
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As of December 31, 2017, the Company had federal and state net operating losses, or NOLs, of $273.5 million and $98.6 million, respectively, and federal and state research and experimentation credit carryforwards of approximately $11.6 million and $4.7 million, respectively, which will expire at various dates starting in 2018 through 2036. As of December 31, 2017, the Company also had orphan drug tax credit carryforwards of $15.6 million, these credits relate to qualified expenses incurred for CUDC-907 since receiving the Orphan Drug designation. As required by U.S. GAAP, the Company’s management has evaluated the positive and negative evidence bearing upon the realizability of its deferred tax assets, and has determined that it is more likely than not that the Company will not recognize the benefits of the deferred tax assets. Accordingly, a valuation allowance of approximately $143.9 million has been established at December 31, 2017. The benefit of deductions from the exercise of stock options is included in the NOL carryforwards.
The valuation allowance (decreased)/increased approximately $(31.4) million, $30.0 million and $23.4 million during the years ended December 31, 2017, 2016 and 2015. The current year decrease in the valuation allowance is primarily due to the impact of the Tax Reform Act on the ending deferred assets which offset the current year increase in net operating loss carryforwards. The increase in 2016 and 2015 is due primarily to the increase in net operating loss carryforwards and tax credits.
Utilization of the NOL and research and development, or R&D, credit carryforwards may be subject to a substantial annual limitation under Section 382 of the Internal Revenue Code of 1986 due to ownership change limitations that have occurred previously or that could occur in the future. These ownership changes may limit the amount of NOL and R&D credit carryforwards that can be utilized annually to offset future taxable income and tax, respectively. The Company has not completed a study to assess whether a change of control has occurred or whether there have been multiple changes of control since the Company’s formation because the Company continues to maintain a full valuation allowance on its NOL and R&D credit carryforwards. In addition, there could be additional ownership changes in the future, which may result in additional limitations in the utilization of the carryforward NOLs and credits, and the Company does not expect to have any taxable income for the foreseeable future.
An individual tax position must satisfy for some or all of the benefits of that position to be recognized in a company’s financial statements. At December 31, 2017 and 2016, the Company had no unrecognized tax benefits. The Company has not, as yet, conducted a study of its R&D credit carryforwards. This study may result in an adjustment to the Company’s R&D credit carryforwards, however, until a study is completed and any adjustment is known, no amounts are being presented as an uncertain tax position under Topic 740. A full valuation allowance has been provided against the Company’s R&D credits and, if an adjustment is required, this adjustment would be offset by an adjustment to the valuation allowance. Thus, there would be no impact to the consolidated balance sheet or statement of operations if an adjustment were required.
The tax years 2002 through 2017 remain open to examination by major taxing jurisdictions to which the Company is subject, which are primarily in the U.S., as carryforward attributes generated in years past may still be adjusted upon examination by the Internal Revenue Service, or IRS, or state tax authorities if they have or will be used in a future period. The Company is currently not under examination by the IRS or any other jurisdictions for any tax years. The Company recognizes both accrued interest and penalties related to unrecognized benefits in income tax expense. The Company has not recorded any interest or penalties on any unrecognized tax benefits since its inception.
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118") to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Reform Act. The Company has recognized the provisional tax impacts related to the revaluation of the deferred tax assets and liabilities and included these amounts in its consolidated financial statements for the year ended December 31, 2017. The ultimate impact may differ from these provisional amounts due to, among other things, additional analysis, changes in interpretations and assumptions the Company has made, additional regulatory guidance that may be issued, and actions the Company may take as a result of the Tax Reform Act. The accounting is expected to be complete when the 2017 U.S. corporate income tax return is filed in 2018.