PHARMATHENE, INC

Note 9 - Income Taxes

The provision for income taxes consists of the following:

	Year ended December 31,
	2016		2015		2014

Current taxes
Federal	$	8,595,085	$	-	$	-
State		2,512,469		-		-
Foreign		-		-		-
Total current taxes		11,107,554		-		-

Deferred taxes
Federal		53,240		53,221		53,221
State		8,582		8,525		8,525
Foreign		-		-		-
Total deferred taxes		61,822		61,746		61,746

Total tax provision	$	11,169,376	$	61,746	$	61,746

A reconciliation of the U.S. statutory rate with the effective tax rate is as follows:

	Year Ended December 31,
	2016			2015			2014

Statutory federal tax provision (benefit)	$	71,758,245		$	(1,148,846)		$	(3,363,841)
State income tax (benefit), net of federal benefit		10,323,810			(124,626)			(450,656)
Other permanent differences		6,211			6,909			(6,274)
Foreign rate differential		4,150			68,482			7,913
Write-off of expired/forfeited options and conversion of notes		181,958			1,049,765			380,689
Rate change		(1,429,996)			1,218			794,807
Lobbying costs		198,491			1,047			57,517
Write-off of tax basis in UK subsidiary		(6,288,553)			-			-
Research and development tax credit		(817,832)			-			-
Other prior year adjustments		-			2,949			(308)
Subtotal		73,936,484			(143,102)			(2,580,153)
(Decrease) increase in valuation allowance		(62,767,108)			204,848			2,641,899
Income tax provision	$	11,169,376		$	61,746		$	61,746

Federal statutory rate		35	%		34	%		34	%

Our effective tax rate for 2016 differs from the U.S. federal statutory rate of 35% due principally to $6.3 million of discrete tax benefits primarily associated with a worthless stock deduction related to the dissolution of one of the Company’s international subsidiaries for tax purposes and $0.8 million of discrete tax benefits recognized upon the completion of a research and development tax credit study that determined federal tax credits available for all open tax years.

For December 31, 2016, the reconciliation to the Federal statutory rate includes a change from using a Federal statutory rate of 34% to 35%. Deferred tax assets have been recorded historically at the Federal statutory tax rate of 34% and, based on the expected lack of taxable income at a level sufficient to warrant the 35% tax rate in years after 2016, the deferred tax assets and liabilities continue to be valued using the Federal statutory rate of 34%. As a result of our significant income during 2016, our usage of net operating losses provided a benefit at a Federal statutory rate of 35%. The reconciling item accounts for the current benefit of 35% on previously deferred tax items valued at 34%. In addition to the U.S. Federal statutory rate change, the UK income tax rate will reduce in 2017 from 20% to 19% and, as a result, deferred tax assets on net operating losses carrying forward in the UK have been revalued to reflect the new tax rate.

Deferred tax assets and liabilities are comprised of the following:

	Year Ended December 31,
	2016		2015		2014

Deferred tax assets:
Net operating loss ("NOLs") carryforwards	$	3,405,069	$	65,635,003	$	64,361,842
Fixed assets		149,099		139,883		166,205
Research and development credits/loss carryforwards		6,849		8,900		3,834
Share-based compensation		1,407,280		2,352,660		3,458,334
Intangible asset		1,139,746		218,300		251,524
Accrued expenses and other		817,080		253,655		434,294
Total deferred tax assets		6,925,123		68,608,401		68,676,033

Deferred tax liabilities:
Intangibles		(442,589)		(380,777)		(319,021)
Total deferred tax liabilities		(442,589)		(380,777)		(319,021)
Net deferred tax assets		6,482,534		68,227,624		68,357,012
Less: Valuation allowance		(6,925,123)		(68,608,401)		(68,676,033)
Net deferred tax liabilities	$	(442,589)	$	(380,777)	$	(319,021)

The classification of deferred tax assets and liabilities for 2015 and 2014 have been conformed to be consistent with the 2016 presentation in the table above.

During the year ended December 31, 2016, previously unrecognized deferred tax assets, primarily related to net operating loss carryforwards, were recognized and utilized against current taxable income generated by payments received from the SIGA lawsuit. Due to the Company’s history of net operating losses and the nonrecurring nature of payments received from SIGA, a valuation allowance of $6.9 million continues to be recorded on remaining net deferred tax assets until such point in time the likelihood of realization would not meet the more likely than not threshold.

Due to prior changes in the stock ownership of the Company, net operating losses are subject to a limitation under Section 382 of the U.S. Internal Revenue Code. As a result of this limitation, approximately $1 million of net operating losses were not available to offset current year taxable income and must be carryforward for use in future years. These losses will begin to expire in 2023. The Company’s UK net operating loss carryforwards of approximately $16 million may be carried forward indefinitely.

Accounting Standard Update 2015-17 requires that all deferred tax assets and deferred tax liabilities be classified as noncurrent. Previous to adopting this accounting standard, we have only reported a non-current deferred tax liability on our balance sheet; therefore, the application of this standard had no effect on our current or historic financials statements.

We have analyzed tax positions in all jurisdictions where the Company is required to file an income tax return and have concluded that we do not have any material unrecognized tax benefits. As such, we believe that any of our uncertain tax positions would not result in adjustments to our effective income tax rate.