9. Income Taxes
On December 22, 2017, the President signed the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act, among other things, lowered the U.S. corporate income tax rate from 35% to 21% effective January 1, 2018. Consequently, our net deferred tax assets as of December 31, 2017 were significantly reduced to reflect the estimated impact of the Tax Act. Due to our lack of earnings history and uncertainties surrounding our ability to generate future taxable income, the net deferred tax assets have been fully offset by a valuation allowance. The significant reduction in our net deferred tax assets are fully offset by a reduction in valuation allowance, resulting in no impact to our income tax expense.
The components of the loss before income taxes were as follows (in thousands):
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Loss before provision for income taxes: |
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United States |
$ | (101,288 | ) | $ | (70,103 | ) | $ | (46,360) | ||||
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International |
(15,736 | ) | (12,365 | ) | — | |||||||
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| $ | (117,024 | ) | $ | (82,468 | ) | $ | (46,360) | |||||
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No provision for income taxes was recorded for the years ended December 31, 2017, December 31, 2016 and December 31, 2015. We have incurred net operating losses for all the periods presented. We have not reflected any benefit of such net operating loss carryforwards in the accompanying consolidated financial statements. We have established a full valuation allowance against the related deferred tax assets due to the uncertainty surrounding the realization of such assets.
The effective tax rate of the provision for income taxes differs from the federal statutory rate as follows:
| Year Ended December 31, | ||||||||||||
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2017 |
2016 |
2015 |
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Federal statutory income tax rate |
34.0 | % | 34.0 | % | 34.0 | % | ||||||
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Non-deductible changes in fair value and other |
0.7 | 3.9 | (4.8 | ) | ||||||||
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Federal and state tax credits |
7.3 | 8.3 | 1.4 | |||||||||
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Change in valuation allowance |
(14.8 | ) | (41.1 | ) | (30.6 | ) | ||||||
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Foreign rate differential |
(4.6 | ) | (5.1 | ) | — | |||||||
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Officer compensation limitation |
(0.9 | ) | — | — | ||||||||
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Tax reform – tax rate change |
(21.7 | ) | 0.0 | % | 0.0 | % | ||||||
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Provision for Taxes |
0.0 | % | 0.0 | % | 0.0 | % | ||||||
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The components of the deferred tax assets and liabilities are as follows (in thousands):
| December 31, | ||||||||
| 2017 | 2016 | |||||||
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Deferred tax assets: |
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Net operating loss carryforwards |
$ | 51,448 | $ | 51,348 | ||||
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Tax credits |
32,732 | 15,167 | ||||||
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Property and equipment |
116 | 9 | ||||||
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Accruals and reserves |
1,668 | 1,739 | ||||||
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Stock based compensation |
1,915 | 1,859 | ||||||
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Gross deferred tax assets |
87,879 | 70,122 | ||||||
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Valuation allowance |
(87,879 | ) | (70,122 | ) | ||||
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Realization of the deferred tax assets is dependent upon future taxable income, if any, the amount and timing of which are uncertain. We have established a valuation allowance to offset deferred tax assets as of December 31, 2017 and 2016 due to the uncertainty of realizing future tax benefits from our net operating loss carryforwards and other deferred tax assets. The valuation allowance increased approximately $17.8 million, $34.0 million, and $16.7 million during the years ended December 31, 2017, 2016, and 2015, respectively. The increase in the valuation allowance is mainly related to the increase in net operating loss carryforwards generated during the respective taxable years.
At December 31, 2017, we had net operating loss carryforwards for Federal income tax purposes of $194.5 million which are available to offset future taxable income, if any, through 2036. We also had net operating loss carryforwards for state income tax purposes of $151.9 million which are available to offset future taxable income, if any. They begin to expire 2032 through 2036. As of December 31, 2017, we had research and development/orphan drug tax credit carryforwards of approximately $30.0 million and $3.4 million available to reduce future taxable income, if any, for federal and state income tax purposes, respectively. If not utilized, the federal credit carryforwards will begin expiring in 2031, and the state credits carryforward indefinitely.
In general, if we experience a greater than 50 percentage point aggregate change in ownership over a three-year period (a Section 382 ownership change), utilization of our pre-change NOL carryforwards are subject to an annual limitation under Section 382 of the Internal Revenue Code (California has similar laws). The annual limitation generally is determined by multiplying the value of our stock at the time of such ownership change (subject to certain adjustments) by the applicable long-term tax-exempt rate. Such limitations may result in expiration of a portion of the NOL carryforwards before utilization. We have not utilized any NOL carryovers through December 31, 2017. In addition, our deferred tax assets are subject to full valuation allowance, and thus no benefit for deferred tax assets are recorded on our books. Our ability to use the remaining NOL carryforwards may be further limited if we experience a Section 382 ownership change as a result of future changes in our stock ownership.
No liability related to uncertain tax positions is recorded on the consolidated financial statements. All uncertain tax positions are currently recorded as a reduction to our deferred tax asset. It is our policy to include penalties and interest expense related to income taxes as a component of other expense and interest expense, respectively, as necessary.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):
| December 31, | ||||||||
| 2017 | 2016 | |||||||
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Balance at beginning of year |
$ | 5,296 | $ | 1,005 | ||||
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Additions based on tax positions related to current year |
6,346 | 4,291 | ||||||
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Decreased for prior period positions |
(492) | |||||||
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Unrecognized tax benefit - December 31 |
$ | 11,150 | $ | 5,296 | ||||
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We do not expect that our uncertain tax positions will materially change in the next twelve months. The reversal of the uncertain tax benefits will not impact our effective tax rate as we continue to maintain a full valuation allowance against our deferred tax assets.
We file income tax returns in the United States, California and other states. We are not currently under examination by income tax authorities in federal, state or other jurisdictions. All tax returns will remain open for examination by the federal and state authorities for three and four years, respectively, from the date of utilization of any net operating loss or credits.