| 12. | Income Taxes |
Prior to the Conversion, the Company has been treated as a partnership for tax purposes and has not been subject to U.S. federal or state income taxation. As a result, since its inception, the Company has not recorded any U.S. federal or state income tax benefits for the net losses incurred in each year or for earned research and orphan drug credits. Upon the Conversion in October 2017, the Company became subject to Corporate U.S. federal and state income taxes.
During the period from October 2, 2017 to December 31, 2017, the Company recorded no income tax benefits for the net operating losses, due to its uncertainty of realizing a benefit from those items.
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 |
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Federal statutory income tax rate |
34.0 | % | ||
|
State taxes, net of federal benefit |
1.6 | |||
|
Federal research and orphan drug credit |
7.7 | |||
|
Federal research and orphan drug credit addback |
(6.6 | ) | ||
|
Impact of change in tax status |
(8.7 | ) | ||
|
Effect of federal tax law change |
(6.1 | ) | ||
|
Permanent adjustments |
(0.3 | ) | ||
|
Increase in the valuation allowance |
(21.6 | ) | ||
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|
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Effective income tax rate |
— | % | ||
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Net deferred tax assets as of December 31, 2017 consisted of the following (in thousands):
| December 31, 2017 |
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|
Deferred tax assets: |
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Net operating loss carryforwards |
$ | 4,030 | ||
|
Research and orphan drug credit carryforwards |
3,888 | |||
|
Stock-based compensation |
2,366 | |||
|
Accrued expenses |
672 | |||
|
Other |
(121 | ) | ||
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|
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Total gross deferred tax assets |
10,835 | |||
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|
|
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Valuation allowance |
(10,835 | ) | ||
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|
|
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Net deferred tax assets |
$ | — | ||
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On December 22, 2017, the Tax Cuts and Jobs Act (the “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 35% 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).
The Company remeasured certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future. The provisional amount related to the re-measurement of the Company’s deferred tax balance was a reduction of $3.1 million. Due to the corresponding valuation allowance fully offsetting deferred taxes, there was no impact to the statement of operations and comprehensive loss.
In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118) which allows the Company to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. Since the Act was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation are expected over the next 12 months, the Company considers the accounting for the effect of the TCJA to be provisional in accordance with SAB 118.
Upon the Conversion in October 2017, the Company became subject to U.S. federal and state income taxes. The change in the valuation allowance was as follows (in thousands):
| Year Ended December 31, 2017 |
||||
|
Valuation allowance as of beginning of year |
$ | — | ||
|
Decreases recorded as benefit to income tax provision |
— | |||
|
Increases recorded to income tax provision |
(10,835 | ) | ||
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|
|
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Valuation allowance as of end of year |
$ | (10,835 | ) | |
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As of December 31, 2017, the Company had net operating loss carryforwards for federal and state income tax purposes of $14.9 million and $15.2 million, respectively, which begin to expire in 2037 and 2027, respectively. As of December 31, 2017, the Company also had available research and orphan drug credit carryforwards for federal and state income tax purposes of $3.8 million and less than $0.1 million, respectively, which begin to expire in 2037 and 2032, respectively. Utilization of the net operating loss carryforwards and research and orphan drug credit carryforwards may be subject to a substantial annual limitation under Section 382 of the Internal Revenue Code of 1986, as amended, (the “Code”), and similar state law 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. The Company has not conducted a formal study to assess whether a change of control has occurred or whether there have been multiple changes of control since the IPO 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 of the Code and similar state law, at any time since the IPO, utilization of the net operating loss carryforwards or research and orphan drug credit carryforwards may be subject to an annual limitation under Section 382 of the Code, 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 research and orphan drug credit carryforwards before utilization.
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 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. 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.
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 that are open under statute are from October 2, 2017 to the present. The Company’s policy is to record interest and penalties related to income taxes as part of its income tax provision.