13. Income Taxes
In 2017 and 2016, the Company recorded an income tax benefit of zero. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and the amounts used for tax purposes as well as net operating loss and tax credit carryforwards.
Income (loss) before provision for income taxes consists as follows (in thousands)
| December 31, | ||||||||
| 2017 | 2016 | |||||||
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United Sates |
$ | (11,465 | ) | $ | (31,594 | ) | ||
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International |
760 | (1,344 | ) | |||||
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Total |
$ | (10,705 | ) | $ | (32,938 | ) | ||
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Significant components of the Company’s deferred tax assets and liabilities were as follows (in thousands):
| December 31, | ||||||||
| 2017 | 2016 | |||||||
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Net operating loss carryforwards |
$ | 18,267 | $ | 25,536 | ||||
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Research and development credits |
7,898 | 6,509 | ||||||
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Federal orphan drug credits |
23,881 | 18,599 | ||||||
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Other |
1,483 | 3,572 | ||||||
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Total deferred tax assets |
51,529 | 54,216 | ||||||
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Valuation allowance |
(51,529 | ) | (54,216 | ) | ||||
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Net deferred tax assets |
$ | — | $ | — | ||||
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The Company considers all available evidence, both positive and negative, including historical levels of taxable income, expectations and risks associated with estimates of future taxable income, and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. At December 31, 2017 and 2016, based on the Company’s analysis of all available evidence, both positive and negative, it was considered more likely than not that the Company’s deferred tax assets would not be realized, and as a result, the Company recorded a valuation allowance for its deferred tax assets. The valuation allowance decreased by $2.7 million during the year ended December 31, 2017 and increased by $16.2 million during the year ended December 31, 2016.
The difference between the income tax benefit and the amount computed by applying the federal statutory income tax rate to loss before income taxes is as follows (in thousands):
| Year Ended December 31, | ||||||||
| 2017 | 2016 | |||||||
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Income tax benefit at federal statutory rate |
$ | (3,746 | ) | $ | (11,531 | ) | ||
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State taxes (net of federal) |
(8 | ) | (391 | ) | ||||
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Credits |
(3,434 | ) | (4,932 | ) | ||||
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Other |
67 | 694 | ||||||
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Change in valuation allowance |
(1,931 | ) | 16,160 | |||||
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Tax Rate Change |
9,052 | — | ||||||
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Total |
$ | — | $ | — | ||||
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On December 22, 2017, H.R.1, known as the “Tax Cuts and Jobs Act,” was signed into law. Among other things, the Tax Cuts and Jobs Act permanently lowers the corporate tax rate to 21% from the existing minimum rate of 35%, effective for tax years including or commencing January 1, 2018. As a result of this reduction of the corporate tax rate to 21% U.S. generally accepted accounting principles require companies to re-value their deferred tax assets and liabilities as of the date of enactment, with resulting tax effects accounted for in the reporting period of enactment. The difference in the net change in the valuation allowance is due to the tax rate change that is separately stated in the rate reconciliation.
The Company has revalued its deferred tax assets and liabilities as of December 31, 2017, at the new rate of 21% based upon balances in existence at date of enactment. Based upon preliminary estimates, it is currently expected that the Company’s net deferred tax assets before valuation allowance will be written down by approximately $9 million in the fourth quarter of 2017. This estimate is based upon a review and analysis of the Company’s net deferred tax assets. The Company’s actual write-down may vary materially from the estimated range due to a number of uncertainties and factors and is subject to further clarification of the new law that cannot be reasonably estimated at this time.
As of December 31, 2017, the Company had federal net operating loss carryforwards of approximately $71.5 million and federal orphan drug credit carryforwards of approximately $23.9 million, which expire in the years 2019 through 2037. The Company also had California net operating loss carryforwards of approximately $44.1 million, which expire in the years 2028 through 2037, and California research and development tax credit carryforwards of approximately $9.9 million, which do not expire.
Utilization of the Company’s NOL and credit carryforwards may be subject to additional annual limitations based on future stock issuances or ownership changes. Such future limitations could result in the expiration of the net operating loss and credit carryforwards before utilization. Based on the analyses performed on ownership changes that have occurred from inception through December 31, 2017, the Company expects to be able to use the NOL and tax credit carryforwards as noted above.
The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is subject to U.S. federal and state income tax examinations by tax authorities for tax years from 1998 due to net operating losses and tax credits that are being carried forward for tax purposes. As of December 31, 2017, the Company does not believe that it is reasonably possible that its unrecognized benefits would significantly change in the following 12 months.
The Company does not have any unrecognized tax benefits, or interest and penalties accrued on unrecognized tax benefits, at December 31, 2017, or during the two years then ended. The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.