Income Taxes
New Tax Legislation
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (“TCJA”). This legislation makes broad and complex changes to the U.S. tax code, including, but not limited to, (i) reducing the U.S. federal statutory tax rate from 35% to 21%; (ii) eliminating the corporate alternative minimum tax (AMT) and changing how existing AMT credits can be realized; (iii) modifying the officer’s compensation limitation, and (iv) changing rules related to uses and limitations of net operating loss carryforwards created in tax years beginning after December 31, 2017. Specifically, the TCJA limits the amount the Company is able to deduct for net operating loss carryforwards generated in taxable years beginning after December 31, 2017 to 80% of taxable income however these net operating loss carryforwards can be carried forward indefinitely.
The Company recognizes the effects of changes in tax law, including the TCJA, in the period the law is enacted. Accordingly, the effects of the TCJA have been recognized in the financial statements for the year ended December 31, 2017. As a result of the change in law, the Company recorded a reduction to its deferred tax assets of $8.6 million and a corresponding reduction to its valuation allowance due to the reduction in the U.S. federal statutory rate from 35% to 21%.
In addition, the new legislation has also repealed the corporate Alternative Minimum Tax (“AMT”) for years after 2017. Corporations that were previously subject to the AMT and therefore have AMT tax credit carryforwards as of December 31, 2017, are eligible for a refund of these credits for tax years beginning after 2017 and before 2022. The Company is subject to AMT in the amount of $1.9 million in 2017. Since the AMT payable in 2017 will generate an AMT credit that will be refundable between 2018 and 2022, the Company has recorded a $1.9 million income tax receivable rather than a tax expense for 2017. Further, the Company also has a deferred tax asset for its AMT credit carryforward related to its AMT liability paid in 2015 in the amount of $0.3 million. This deferred tax asset was previously offset by a full valuation allowance. As a result of the change in law, the Company has reclassified the 2015 AMT credit carryforward from deferred tax assets to income tax receivable. The Company has recorded a current period tax benefit of $0.3 million related to the reversal of the valuation allowance on its 2015 AMT credit carryforward as this amount is now refundable.
At December 31, 2017, the Company has not completed its accounting for the tax effects of the enactment of the TCJA; however in certain cases we have made a reasonable estimate of the effects of the TCJA. For the items for which we were able to determine a reasonable estimate, we recorded an $8.6 million reduction to deferred tax assets with an offset to valuation allowance and recognized a provisional benefit for income taxes of $0.3 million for the year ended December 31, 2017. The Company’s preliminary estimate of the effects TCJA, including the remeasurement of deferred tax assets and liabilities and the recognition of an income tax benefit related to AMT tax credit carryforwards, is subject to the finalization of management’s analysis related to certain matters, such as developing interpretations of the provisions of the TCJA and the filing of the Company’s tax returns. U.S. Treasury regulations, administrative interpretations or court decisions interpreting the TCJA may require further adjustments and changes in our estimates. The final determination of the effects of the TCJA will be completed as additional information becomes available, but no later than one year from the enactment of the TCJA. In all cases, we will continue to make and refine our calculations as additional analysis is completed. In addition, our estimates may also be affected as we gain a more thorough understanding of the tax law.
Income Taxes
During the year ended December 31 2017, the Company recorded net income before taxes of $95.3 million. As a result of the enactment of the TCJA, which allows for AMT to be refundable, the Company recorded a tax receivable of $2.2 million as of December 31, 2017 and a $0.3 million income tax benefit during the year ended December 31, 2017. The tax benefit is the result of the removal of its valuation allowance on its AMT credit carryforward as previously described. Income taxes that would otherwise have been due on the 2017 taxable income were offset with the tax benefit of net operating loss carryforwards which had previously had a full valuation allowance, except for $1.9 million of AMT incurred due to the limitation on use of net operating loss carryforwards when determining AMT. However, the 2017 AMT is also refundable under the Tax Cuts and Jobs Act of 2017 and thus we have not recorded a tax provision for this amount. The total amount of refundable AMT credits of $2.2 million is reflected as income tax receivable in the accompanying consolidated balance sheet as of December 31, 2017. We provide a full valuation allowance for any tax benefit related to net operating losses due to the uncertainty of the ability to realize such benefits.
During the year ended December 31, 2016, the Company recorded a net loss of $50.7 million and, since it maintained a full valuation allowance on its deferred tax assets, the Company did not record an income tax benefit for the year ended December 31, 2016. The Company recorded $0.4 million in income tax expense during the year ended December 31, 2015. The tax expense is the result of alternative minimum tax (“AMT”) which, in accordance with the U.S. federal tax code as of December 31, 2015, limited the use of net operating loss carryforwards to ninety percent of AMT income resulting in an effective tax rate of approximately two percent.
The Company’s ability to use its operating loss carryforwards and tax credit carryforwards to offset taxable income is subject to restrictions under Sections 382 and 383 of the United States Internal Revenue Code (the “Internal Revenue Code”). Net operating loss and tax credit carryforwards are subject to an annual limitation in the event of certain cumulative changes in the ownership interest of significant shareholders over a three-year period in excess of 50 percent, as defined under Sections 382 and 383 of the Internal Revenue Code. Such changes would limit the Company’s use of its operating loss and tax credit carryforwards. In such a situation, the Company may be required to pay income taxes, even though significant operating loss and tax credit carryforwards exist. Additionally, any future financing could result in a change in control, as defined by Sections 382 and 383, which could further limit the Company's use its operating loss and tax credit carryforwards. In determining the tax provisions for fiscal years 2017 and 2015, we assessed our ability to use our net operating loss carryforwards in accordance with Sections 382 and 383 of the Internal Revenue Code.
A reconciliation of the federal statutory income tax rate and the Company’s effective income tax rate is as follows:
|
| | | | | | | | | |
| | Year ended December 31, |
| | 2017 | | 2016 | | 2015 |
Federal statutory income tax rate | | (35.0 | )% | | 34.0 | % | | (34.0 | )% |
State income taxes | | (5.1 | )% | | 4.5 | % | | (5.3 | )% |
Change in valuation allowance | | 46.2 | % | | (40.3 | )% | | 32.6 | % |
Research and development and other credits | | 2.5 | % | | 3.1 | % | | 7.8 | % |
Permanent items | | 0.8 | % | | (1.0 | )% | | (0.3 | )% |
Alternative minimum tax | | — | % | | — | % | | (1.7 | )% |
Other | | — | % | | (0.3 | )% | | (0.8 | )% |
Federal rate change | | (9.1 | )% | | — | % | | — | % |
Effective income tax rate | | 0.3 | % | | — | % | | (1.7 | )% |
The significant components of the Company’s net deferred tax assets consist of the following (in thousands):
|
| | | | | | | |
| December 31, |
| 2017 | | 2016 |
Net operating loss carryforwards | $ | 11,670 |
| | $ | 53,809 |
|
Deferred revenue | 2,733 |
| | 3,948 |
|
Research and development and other credit carryforwards | 13,399 |
| | 10,791 |
|
Other | 3,811 |
| | 3,851 |
|
| 31,613 |
| | 72,399 |
|
Valuation allowance | (31,613 | ) |
| (72,399 | ) |
Net deferred tax assets | $ | — |
| | $ | — |
|
Subject to the limitations described above and the impacts of the TCJA, at December 31, 2017, the Company had gross federal net operating loss carryforwards of $54.9 million and state net operating loss carryforwards of $2.2 million available to reduce future taxable income, which expire at various dates beginning in 2028. The Company also had federal and state tax credit carryforwards of $9.9 million and $4.3 million, respectively, available to reduce future tax liabilities, which expire at various dates through 2037.
The Company adopted ASU 2016-09, Improvements to Employee Share-Based Payment Accounting on January 1, 2017. As a result of adoption, the deferred tax assets associated with net operating losses as of December 31, 2016 have increased by $3.2 million. These amounts were offset by a corresponding increase in the valuation allowance. The adoption of ASU 2016-09 has no impact on the Company’s operations, financial position or cash flows.
Realization of the future tax benefits is dependent on many factors, including the Company’s ability to generate taxable income within the carryforward period. The Company has evaluated the positive and negative evidence bearing upon the realizability of its deferred tax assets and concluded that it is more likely than not that the Company will not realize the benefit of its deferred tax assets. As a result, the deferred tax assets have been fully reserved at December 31, 2017 and 2016.
At December 31, 2017, the Company had no unrecognized tax benefits. The Company has not conducted a study of its research and development credit carryforwards. A study may result in an adjustment to the Company’s research and development credit carryforwards; however, until a study is completed and any adjustment is known, no amounts will be presented as an uncertain tax position. A full valuation allowance has been provided against the Company’s research and development credit carryforwards and, if an adjustment is required, this adjustment would be offset by an adjustment to the valuation allowance. Thus, there would be no impact to the consolidated balance sheet or statement of operations if an adjustment were required.
Interest and penalty charges, if any, related to unrecognized tax benefits would be classified as income tax expense in the accompanying statement of operations. As of December 31, 2017, the Company had no accrued interest related to uncertain tax positions.
The Company is currently open to examination under the statute of limitations by the Internal Revenue Service and state jurisdictions for the tax years ended 2014 through 2016. Carryforward tax attributes generated in years prior to 2011 may still be adjusted upon future examination if they have or will be used in a future period. The Company is currently not under examination by the Internal Revenue Service or any other jurisdictions for any tax years. Since the Company is in a loss carryforward position, the Company is generally subject to examination by the U.S. federal, state and local income tax authorities for all tax years in which a loss carryforward is available.