14. Income Taxes
The Company uses an asset and liability approach for financial accounting and reporting of income taxes. Deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax basis of assets and liabilities and are measured by applying enacted rates and laws to taxable years in which differences are expected to be recovered or settled. Further, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that the rate changes.
The Company applies the provisions of ASC 740, Income Taxes, which prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return (including a decision whether to file or not file a return in a particular jurisdiction). The Company’s financial statements reflect expected future tax consequences of such positions presuming the taxing authorities’ full knowledge of the position and all relevant facts.
The Company does not have any interest or penalties accrued related to uncertain tax positions as it does not have any unrecognized tax benefits. In the event the Company determines that accrual of interest or penalties is necessary in the future, the amount will be presented as a component of income taxes.
On December 22, 2017, the President signed into law new legislation, known as the Tax Cuts and Jobs Act of 2017 (the “Tax Act”), that resulted in significant changes to the Internal Revenue Code of 1986, as amended. These changes include a federal statutory rate reduction from 35% to 21%, limitation of the deduction for net operating losses to 80% of taxable income while providing that the net operating loss carryovers for years after 2017 will not expire, limitation on the amount of research and development expenses deductible per year beginning in years after 2021, reduction of the Orphan Drug Credit from 50% to 25% of qualified clinical testing expenditures, increased limitations on certain executive compensation, elimination of the Corporate Alternative Minimum Tax, and modifying or repealing other business deductions and credits.
As a result of the Tax Act being signed into law, the Company recognized a provisional charge of $52,653 in the fourth quarter of 2017 related to the re-measurement of its U.S. deferred tax assets at the lower enacted corporate tax rate. Due to the history of net operating losses, the Company is in a full valuation allowance position. As a result, the additional tax expense due to the Tax Act was offset by an equal reduction to the valuation allowance, resulting in no net tax impact from the Tax Act to the overall financial condition and results of operations of the Company.
The income tax provision (benefit) consists of the following:
| As of December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Deferred: |
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Federal and state |
$ | 15,506 | $ | (23,232 | ) | $ | 699 | |||||
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Valuation allowance |
(15,506 | ) | 23,232 | (699 | ) | |||||||
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Total deferred |
$ | — | $ | — | $ | — | ||||||
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A reconciliation of the statutory tax rates to the effective tax rates is as follows:
| Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Federal statutory rate |
(34.0 | )% | (34.0 | )% | (34.0 | )% | ||||||
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State tax, net of federal benefit |
(5.0 | ) | (5.0 | ) | (5.0 | ) | ||||||
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Other |
(0.46 | ) | 0.06 | 0.52 | ||||||||
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Share-based compensation |
0.35 | 0.80 | 2.84 | |||||||||
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Change in federal tax rate |
61.77 | — | — | |||||||||
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Valuation allowance |
(22.66 | ) | 38.14 | 35.64 | ||||||||
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| 0 | % | 0 | % | 0 | % | |||||||
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Future tax benefits (deferred tax assets) related to temporary differences are as follows:
| As of December 31, | ||||||||
| 2017 | 2016 | |||||||
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Gross deferred tax assets: |
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Net operating losses |
$ | 115,009 | $ | 127,376 | ||||
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Tax credits (federal and state) |
13,480 | 10,758 | ||||||
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Share-based compensation |
9,720 | 10,725 | ||||||
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Other |
282 | 24 | ||||||
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| $ | 138,491 | $ | 148,883 | |||||
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Less—valuation allowance |
(138,491 | ) | (148,883 | ) | ||||
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Net deferred tax asset |
$ | — | $ | — | ||||
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At December 31, 2017 and 2016, the Company had gross deferred income tax assets of approximately $138,491 and $148,883, respectively, which result primarily from net operating loss and tax credit carryforwards. ASC 740 requires that a valuation allowance be established when it is “more likely than not” that all or a portion of deferred tax assets will not be realized. A review of all positive and negative evidence is required when measuring the need for a valuation allowance. The Company’s cumulative loss from inception represents sufficient negative evidence to require a valuation allowance. The Company concluded that it is appropriate to maintain a full valuation allowance for its net deferred tax assets. Additionally, the Company intends to maintain a valuation allowance until sufficient positive evidence exists to support its reversal.
At December 31, 2017, the Company had the following net operating loss and credit carryforwards available:
| As of December 31, 2017 |
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Federal net operating loss carryforwards |
$ | 369,929 | ||
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State net operating loss carryforwards |
497,646 | |||
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Federal research and development credit carryforwards |
6,859 | |||
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State research and development credit carryforwards |
6,047 | |||
The Company’s federal net operating loss carryforwards expire commencing in 2018 through 2037 and state net operating loss carryforwards which expire commencing in 2020 through 2037. The Company’s federal research and development credit carryforwards expire commencing in 2028 through 2036. The Connecticut research and development carryforwards have no expiration period.
Deferred tax assets relating to tax benefits of employee stock options have been reduced to reflect exercises. Some exercises resulted in tax deductions in excess of previously recorded benefits based on the option value at the time of grant (“windfalls”). Prior to the adoption of ASU 2016-09 for the year ended December 31, 2017, the additional tax benefit associated with the windfall was not recognized until the deduction reduced taxes payable. Accordingly, the tax benefit of approximately $14,579 of the net operating loss carryforwards available but previously unrecognized, have been recognized upon adoption of ASU 2016-09. There was an offsetting adjustment to the valuation allowance equal to the tax benefit recognized for the windfall, resulting in no net tax impact upon adoption of ASU 2016-09.
Utilization of the net operating losses and research and development credit carryforwards may be subject to a substantial annual limitation under Section 382 of the Internal Revenue Code of 1986, or Section 382, due to changes in ownership of the Company that have occurred previously or that could occur in the future. The changes in ownership resulted in net operating loss carryforwards and research and development credits that the Company expects to expire unutilized and thus are not included in gross deferred tax assets disclosed above. The Company will continue to update its analysis of ownership changes and the potential limitations on its deferred tax assets.
The federal and state tax authorities could challenge tax positions taken by the Company for the periods for which there are open tax years. Years subject to audit are years in which unused net operating losses were generated that remain open by the statute of limitations. The Company is open to challenge for the periods of 2006 through 2017 in federal and the State of Connecticut jurisdictions.
The Company did not have any unrecognized tax benefits as of December 31, 2017 and 2016.
The State of Connecticut provides companies with the opportunity to exchange certain research and development credit carryforwards for cash in exchange for foregoing the carryforward of the research and development credit. The program provides for such exchange of the research and development credits at a rate of 65% of the annual research and development credit, as defined. The Company records the benefit for the estimated proceeds from the exchange as a reduction of research and development expenditures.