11. Income Taxes
During the years ended December 31, 2017, 2016 and 2015, the Company recorded no income tax benefits for the net operating losses incurred in each year due to its uncertainty of realizing a benefit from those items.
The domestic and foreign components of loss before income taxes are as follows:
| 2017 | 2016 | 2015 | ||||||||||
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Domestic |
$ | (49,954 | ) | $ | (57,799 | ) | $ | (72,147 | ) | |||
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Foreign |
(2,074 | ) | (79 | ) | (2,139 | ) | ||||||
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Loss before income taxes |
$ | (52,028 | ) | $ | (57,878 | ) | $ | (74,286 | ) | |||
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A reconciliation of the U.S. federal statutory income tax rate to the Company’s effective income tax rate is as follows:
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Federal statutory income tax rate |
(34.0 | %) | (34.0 | %) | (34.0 | %) | ||||||
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Federal and state research and development tax credit |
(4.1 | ) | (2.9 | ) | (3.9 | ) | ||||||
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State taxes, net of federal benefit |
(2.4 | ) | (3.9 | ) | (3.9 | ) | ||||||
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Orphan drug tax credit |
0.0 | (1.3 | ) | (3.5 | ) | |||||||
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Stock compensation expense |
1.5 | 0.7 | 0.9 | |||||||||
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Nondeductible Australia research and development expenses |
1.4 | 0.0 | 1.0 | |||||||||
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Impact of federal rate change related to tax reform |
65.2 | 0.0 | 0.0 | |||||||||
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Other items |
1.2 | 1.3 | 0.1 | |||||||||
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Change in deferred tax asset valuation allowance |
(28.8 | ) | 40.1 | 43.3 | ||||||||
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Effective income tax rate |
0.0 | % | 0.0 | % | 0.0 | % | ||||||
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Net deferred tax assets as of December 31, 2017 and 2016 consisted of the following:
| December 31, | ||||||||
| 2017 | 2016 | |||||||
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Noncurrent deferred tax assets: |
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Capitalized research and development expenses |
49,325 | 59,489 | ||||||
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Net operating loss carryforwards |
13,848 | 14,991 | ||||||
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Tax credit carryforwards |
16,759 | 14,297 | ||||||
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Capitalized legal expenses |
1,646 | 2,119 | ||||||
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Stock-based compensation |
5,568 | 6,027 | ||||||
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Accrued expenses |
522 | 783 | ||||||
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Other temporary differences |
13 | 14 | ||||||
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Total noncurrent deferred tax assets |
87,681 | 97,720 | ||||||
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Total gross deferred tax assets |
87,681 | 97,720 | ||||||
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Valuation allowance |
(87,681 | ) | (97,720 | ) | ||||
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Net deferred tax assets |
$ | — | $ | — | ||||
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Changes in the valuation allowance for deferred tax assets during the years ended December 31, 2017, 2016 and 2015 related primarily to changes in net operating loss carryforwards, capitalized research and development expenses and tax credit carryforwards and were as follows:
| Year Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
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Valuation allowance as of beginning of year |
$ | 97,720 | $ | 74,541 | $ | 42,398 | ||||||
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Decreases recorded as benefit to income tax provision |
(10,039 | ) | — | — | ||||||||
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Increases recorded to income tax provision |
— | 23,179 | 32,143 | |||||||||
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Valuation allowance as of end of year |
$ | 87,681 | $ | 97,720 | $ | 74,541 | ||||||
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As of December 31, 2017, the Company had net operating loss carryforwards for federal and state income tax purposes of $54.0 million and $39.6 million, respectively, which begin to expire in 2026 and 2030, respectively. As of December 31, 2017, the Company also had available tax credit carryforwards for federal and state income tax purposes of $14.8 million and $2.4 million, respectively, which begin to expire in 2026 and 2021, respectively. Utilization of the net operating loss carryforwards and tax credit carryforwards may be subject to a substantial annual limitation under Section 382 of the Internal Revenue Code of 1986 due to ownership changes that have occurred previously or that could occur in the future. These ownership changes may limit the amount of carryforwards that can be utilized annually to offset future taxable income.
On January 1, 2017 the Company adopted new accounting guidance released in March 2016 that updates the accounting for certain aspects of share-based payments to employees, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the consolidated statement of cash flows. On January 1, 2017, the deferred tax assets associated with federal and state net operating loss carryforwards and the capitalized research and development expense increased in the amounts of $9.4 million, $7.2 million and $3.4 million, respectively, offset by valuation allowance. The adoption of this standard did not impact the Company’s consolidated financial statements.
In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain stockholders or public groups in the stock of a corporation by more than 50% over a three-year period. The Company has not conducted a study to assess whether a change of control has occurred or whether there have been multiple changes of control since inception due to the significant complexity and cost associated with such a study. If the Company has experienced a change of control, as defined by Section 382, at any time since inception, utilization of the net operating loss carryforwards or tax credit carryforwards would be subject to an annual limitation under Section 382, which is determined by first multiplying the value of the Company’s stock at the time of the ownership change by the applicable long-term tax-exempt rate, and then could be subject to additional adjustments, as required. Any limitation may result in expiration of a portion of the net operating loss carryforwards or tax credit carryforwards before utilization. Further, until a study is completed and any limitation is known, no amounts are being presented as an uncertain tax position.
As of December 31, 2017 and 2016, the Company’s gross deferred tax asset balance of $87.7 million and $97.7 million, respectively, was comprised principally of net operating loss carryforwards, capitalized research and development expenses and tax credit carryforwards. During the years ended December 31, 2017, 2016 and 2015, gross deferred tax assets (decreased) increased due to additional net operating loss carryforwards, research and development tax credits generated and additional research and development expenses capitalized for tax purposes.
The Company has evaluated the positive and negative evidence bearing upon its ability to realize the deferred tax assets. Management has considered the Company’s history of cumulative net losses incurred since inception and its lack of commercialization of any products or generation of any revenue from product sales since inception and has concluded that it is more likely than not that the Company will not realize the benefits of the deferred tax assets. Accordingly, a full valuation allowance has been established against the deferred tax assets as of December 31, 2017 and 2016. Management reevaluates the positive and negative evidence at each reporting period.
The Company has not recorded any amounts for unrecognized tax benefits as of December 31, 2017 or 2016.
The Company files tax returns as prescribed by the tax laws of the jurisdictions in which it operates. In the normal course of business, the Company is subject to examination by federal and state jurisdictions, where applicable. There are currently no pending income tax examinations. The Company’s tax years are still open under statute from 2013 to the present. Earlier years may be examined to the extent that tax credit or net operating loss carryforwards are used in future periods. The Company’s policy is to record interest and penalties related to income taxes as part of its income tax provision.
On December 22, 2017, the Tax Cuts and Jobs Act ( “TCJA”) was signed into United States law. The TCJA includes a number of changes to existing tax law, including, among other things, a permanent reduction in the federal corporate income tax rate from a top marginal rate of 34% down to a flat rate of 21%, effective as of January 1, 2018, as well as limitation of the deduction for net operating losses to 80% of annual taxable income and elimination of net operating loss carrybacks, in each case, for losses arising in taxable years beginning after December 31, 2017 (though any such net operating losses may be carried forward indefinitely).
As a result of the TCJA, the Company was required to revalue deferred tax assets and liabilities at 21%. This revaluation resulted in a provision of $33.8 million to income tax expense in continuing operations and a corresponding reduction in the valuation allowance. There was no impact to the Company’s consolidated statements of operations and comprehensive loss as a result of the reduction in rates. The other provisions of the TCJA did not have a material impact on the Company’s consolidated financial statements. In accordance with authoritative guidance issued by the Securities and Exchange Commission (“SEC”), the income tax effect of the TCJA represent provisional amounts for which the Company’s accounting is incomplete but for which reasonable estimates were determined and recorded during the fourth quarter of 2017. The guidance provides for a measurement period, up to one year from the enactment date, in which provisional amounts may be adjusted when additional information is obtained, prepared and analyzed. Adjustments to provisional amounts identified during the measurement period will be recorded during fiscal year 2018 to reflect any such guidance provided.