NEWLINK GENETICS CORP

Income Taxes

U.S. Tax Reform

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act makes broad and complex changes to the U.S. tax code that affect fiscal 2017. The Tax Act also makes a number of changes to U.S. federal income tax laws that will affect 2018 and later years, including, but not limited to, a reduction of the U.S. federal corporate income tax rate from 35% to 21%, the repeal of the corporate alternative minimum tax ("AMT"), the limitation on net operating loss deductions to 80 percent of taxable income for losses beginning after December 31, 2017 and the repeal of the current two-year carryback provision for net operating losses arising after 2017.

In connection with its analysis of the impact of the Tax Act, the Company has recorded a net tax benefit of $140,000 in 2017 which is for the release of the valuation allowance that had previously been recorded to offset the AMT deferred income tax benefit and classified this amount as a noncurrent income tax receivable. The Tax Act provides that AMT credit carryovers are partially refundable beginning in 2018 as an offset to a tax liability. The Company expects the amount to be fully refunded by 2021. The Tax Act had no other material impacts to the consolidated financial statements upon enactment.

Income tax benefit (expense) consists of (in thousands):



	Current			Deferred		Total
Year Ended December 31, 2017:
U.S. federal	$	332		$	140	$	472
State and local	87			—		87
	$	419		$	140	$	559

Year Ended December 31, 2016:
U.S. federal	$	6,469		$	—	$	6,469
State and local	(1,113		)	—		(1,113		)
	$	5,356		$	—	$	5,356

Year Ended December 31, 2015:
U.S. federal	$	(5,522	)	$	—	$	(5,522	)
State and local	(1,216		)	—		(1,216		)
	$	(6,738	)	$	—	$	(6,738	)

The tax effects of temporary differences that give rise to significant portions of deferred tax assets and the deferred tax liability at December 31, 2017 and 2016 are presented below (in thousands):



	Year Ended December 31,
	2017			2016
Deferred tax assets:
Net operating loss carryforwards	$	10,622		$	654
Federal research and development tax credits	26,327			20,836
Share-based compensation	11,780			11,843
Deferred rent	327			491
Minimum tax credits	—			143
Accrued compensation	789			427
Unearned revenue	17			163
Charitable contributions	39			13
Leasehold improvements and equipment	297			552
Gross deferred tax assets	50,198			35,122
Less valuation allowance	(50,198		)	(35,122		)
Total deferred tax assets	—			—

The valuation allowance for deferred tax assets as of December 31, 2017 and 2016 was $50.2 million and $35.1 million, respectively. The net change in the total valuation allowance for the years ended December 31, 2017 and 2016 was an increase of $15.1 million and of $14.4 million, respectively. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected taxable income, and tax planning strategies in making this assessment. Valuation allowances have been established for the entire amount of the net deferred tax assets as of December 31, 2017 and 2016, due to the uncertainty of future recoverability.

Federal operating loss carryforwards as of December 31, 2017 of approximately $38.8 million and federal research credit carryforwards of approximately $26.2 million expire at various dates from 2026 through 2035. Sections 382 and 383 of the Internal Revenue Code limit a corporation’s ability to utilize its net operating loss carryforwards and certain other tax attributes (including research credits) to offset any future taxable income or tax if the corporation experiences a cumulative ownership change of more than 50% over any rolling three year period. State net operating loss carryforwards (and certain other tax attributes) may be similarly limited. An ownership change can therefore result in significantly greater tax liabilities than a corporation would incur in the absence of such a change and any increased liabilities could adversely affect the corporation’s business, results of operations, financial condition and cash flow.

Based on analysis from its inception through December 31, 2016, the Company experienced Section 382 ownership changes in September 2001 and March 2003 and one of its subsidiaries experienced Section 382 ownership changes in January 2006 and January 2011 and the reported deferred tax assets reflect these expected limitations. These ownership changes limited the Company's ability to utilize federal net operating loss carryforwards (and certain other tax attributes) that accrued prior to the respective ownership changes of the Company and one of its subsidiaries. Additional ownership changes may occur in the future as a result of events over which the Company will have little or no control, including purchases and sales of the Company’s equity by our 5% stockholders, the emergence of new 5% stockholders, additional equity offerings or redemptions of the Company’s stock or certain changes in the ownership of any of the Company’s 5% stockholders.

A reconciliation of income taxes at the statutory federal income tax rate to net income tax expense (benefit) included in the accompanying statements of operations is set forth in the following table:



	Year ended December 31,
	2017		2016		2015
U.S. federal income tax expense (benefit) at the statutory rate	(35.00	)%	(35.00	)%	(35.00	)%
Available research and experimentation tax credits	—		—		(2.30	)
State income taxes, net of federal taxes	(0.03	)	0.88		(0.50	)
Loss in foreign subsidiary	7.36		15.88		43.60
Valuation allowance, including impact of tax reform	24.10		12.07		13.70
Other	2.80		0.25		0.50
Total	(0.77	)%	(5.92	)%	20.00	%

The loss in foreign subsidiary reconciling item in the above table is the tax effect of intercompany research and development expenses which are not deductible on the Company's consolidated federal income tax return.

The Company accounts for the effect of any uncertain tax positions based on a more likely than not threshold to the recognition of the tax positions being sustained based on the technical merits of the position under scrutiny by the applicable taxing authority. If a tax position or positions are deemed to result in uncertainties of those positions, the unrecognized tax position is estimated based on a cumulative probability assessment that aggregates the estimated tax liability for all uncertain tax positions. Interest and penalties assessed, if any, are accrued and recorded in either interest expense or miscellaneous expense, respectively in the consolidated statement of operations. During the year ended December 31, 2017, the Company recorded interest and penalties relating to its uncertain tax position of $335,000 in its consolidated statement of operations in interest expense and other expenses. No interest or penalties were recorded for the years ended December 31, 2016 and 2015. The liability for uncertain tax benefits consists of estimated federal and state income tax liabilities in years for which the statute of limitations is open. Open years range from 2014 through 2016.

The changes in the Company's uncertain income tax positions for the year ended December 31, 2017 consisted of the following (in thousands):




	December 31, 2017
Beginning Balance - uncertain tax positions	$	653
Increases for tax positions related to current year	—
Decreases due to settlements with taxing authorities	—
Reductions due to lapsed statute of limitations	—
Ending Balance - uncertain tax positions	$	653

The Company does not anticipate the liability for uncertain tax positions as of December 31, 2017 to significantly change in the next 12 months. The Company is currently under IRS examination for its federal tax returns for the years ending December 31, 2016 and 2014.