(9) INCOME TAXES:
Differences between accounting rules and tax laws cause differences between the basis of certain assets and liabilities for financial reporting purposes and tax purposes. The tax effect of these differences, to the extent they are temporary, is recorded as deferred tax assets and liabilities. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred assets and liabilities. Temporary differences which give rise to deferred tax assets and liabilities consist of net operating loss carryforwards, stock compensation expense not deducted for tax purposes until trading restrictions are removed and declared as compensation by the recipient, and accelerated depreciation methods for income tax purposes.
If all of our net operating loss carryforwards and temporary deductible differences were used, we would realize a net deferred tax asset of approximately $3,616,000 based upon expected income tax rates. Under ASC 740, deferred tax assets must be reduced by a valuation allowance if it is likely that all or a portion of it will not be realized. At December 31, 2016, we have determined it is more likely than not that we will not realize our temporary deductible differences and net operating loss carryforwards, and have provided a 100% valuation allowance on our net deferred tax asset.
Positive evidence we evaluated in the order of significance and weighting in our evaluation includes the amount of net operating loss carryforward utilized against current income tax liabilities in four of the prior ten years, and the length of time the net operating loss carryforwards are available before they expire. Negative evidence we considered in the order of significance and weighting in our evaluation include our recent net losses, our plans for continued clinical trial and product development expenses, the timing of expiration of the net operating loss carryforwards prior to being utilized, unpredictability of future sales and profitability, competition from others, and new government regulations. We determined greatest weight should be given to our plans for continued clinical trial and product development expenses, trend of increasing expenses, and recent net operating losses in our evaluation.
The income tax disclosures for the year ended December 31, 2015 have been revised to reflect the inclusion of tax credits that were not included in the prior year financial statement disclosures. This correction had no effect on assets, liabilities, stockholder’s equity and net income as originally reported for the year ended December 31, 2015. The Company has determined that the impact of these revisions on its previously filed consolidated financial statements was not material.
For 2015, we calculated our deferred tax asset using the temporary deductible timing differences plus the net operating loss carryforward multiplied by our expected effective income tax rate. We estimated our future taxable income based on historical results and expected future trends in sales and margins. We estimated the timing of deducting our temporary deductible differences. We estimated the amount of our net operating loss carryforward we would be able to utilize prior to expiration. We increased our valuation allowance to 100% and recorded income tax expense of $120,000. We re-measure our valuation allowance each quarter based on changes in our current and expected future sales and margins, and changes in the other factors of both positive and negative evidence.
We have available at December 31, 2016, unused federal and state net operating loss carryforwards totaling approximately $6,166,000 that may be applied against future taxable income.
If not used, the net operating loss carryforwards will expire as follows:
|
Year Ending December 31, |
Amount | |||
| 2020 | $ | 174,000 | ||
| 2021 | 71,000 | |||
| 2024 | 66,000 | |||
| 2028 | 7,000 | |||
| 2030 | 160,000 | |||
| 2031 | 73,000 | |||
| 2032 | 48,000 | |||
| 2034 | 727,000 | |||
| 2035 | 1,969,000 | |||
| 2036 | 2,871,000 | |||
| Total | $ | 6,166,000 | ||
The Company believes a change in ownership pursuant to Section 382 of the Internal Revenue Code occurred during 2014. As a result, net operating losses in existence as of the date of the ownership change are subject to an annual Section 382 limitation. At December 31, 2016, the amount of net operating losses subject to an annual Section 382 limitation has not been determined.
In 2015 and 2016, the Company had expenses that qualified for the Orphan Drug Credit. The Orphan Drug Credit may be used to offset any current tax liabilities. Unused credits may be carried forward for 20 years. If the credit has not been used by the end of the 20 year carryforward period, it can be deducted for federal income tax purposes. The unused credit carryforwards were $329,663 and $1,262,026 for 2015 and 2016 respectively.
For 2016, the Company did not recognize a benefit or provision for income taxes. The net deferred tax asset before the valuation allowance increased $2,164,000 from 2015 to 2016, which is primarily the result of an additional net operating loss for 2016. We increased our valuation allowance to offset this increase in our deferred tax asset. For 2015, we recognized a $120,000 provision for income taxes, which was due to the increase in our valuation allowance to 100% of net deferred tax assets. Our net deferred tax asset before the valuation allowance increased $1,242,000 from 2014 to 2015, which is primarily the result of an additional net operating loss for 2015. We increased our valuation allowance to offset this increase in our deferred tax asset as well as our previously recognized deferred tax assets.
The components of our (provision) for income taxes are as follows for the years ended December 31:
| 2016 | 2015 | |||||||
| Current: | ||||||||
| Federal | $ | - | $ | - | ||||
| State | - | - | ||||||
| Total Current | $ | - | $ | - | ||||
| Deferred: | ||||||||
| Federal | $ | - | $ | (102,460 | ) | |||
| State | - | (17,540 | ) | |||||
| Total Deferred | - | (120,000 | ) | |||||
| Total tax expense | $ | - | $ | (120,000 | ) | |||
Significant components of our deferred Federal income taxes were as follows:
| 2016 | 2015 | |||||||
| Deferred tax assets: | ||||||||
| Net operating loss carryforwards | $ | 2,321,000 | $ | 1,240,000 | ||||
| Tax credits | 1,262,000 | 330,000 | ||||||
| Impairment allowances | 8,000 | 89,000 | ||||||
| Stock compensation | 27,000 | 28,000 | ||||||
| Other | 6,000 | - | ||||||
| Less valuation allowance | (3,616,000 | ) | (1,452,000 | ) | ||||
| Deferred tax assets, net of valuation | 8,000 | 235,000 | ||||||
| Deferred tax liabilities: | ||||||||
| Property and equipment | (8,000 | ) | (235,000 | ) | ||||
| Deferred tax liabilities | (8,000 | ) | (235,000 | ) | ||||
| Net tax assets | $ | - | $ | - | ||||
The differences between the effective income tax rate reflected in the benefit (provision) for income taxes and the amounts, which would be determined by applying federal statutory income tax rate of 34% is summarized as follows:
| 2016 | 2015 | |||||||
| Tax benefit (expense) at Federal statutory rate | $ | 1,436,000 | $ | 827,000 | ||||
| Effect of State taxes | 153,000 | 88,000 | ||||||
| Tax credits | 932,000 | 330,000 | ||||||
| Nondeductible expenses | (357,000 | ) | (123,000 | ) | ||||
| Other | 215,000 | - | ||||||
| Valuation allowance – deferred tax assets | (2,164,000 | ) | (1,242,000 | ) | ||||
| Total tax benefit (provision) | $ | - | $ | (120,000 | ) | |||
The Company files income tax returns in the U.S. Federal jurisdiction, and in the State of Florida. The Company is no longer subject to U.S. Federal or state income tax examinations by tax authorities for years before 2013.
The Company has reviewed and evaluated the relevant technical merits of each of its tax positions in accordance with accounting principles generally accepted in the United States of America for accounting for uncertainty in income taxes, and determined that there are no uncertain tax positions that would have a material impact on the financial statements of the Company. When applicable, interest and penalties will be reflected as a component of income tax expense.