CYTOKINETICS INC

Note 12 — Income Taxes

The Company did not record an income tax provision in the years ended December 31, 2017, 2016, and 2015 because the Company either had net taxable losses or was able to utilize tax attributes to offset taxable income.

The following is a reconciliation of the statutory federal income tax rate to the Company’s effective tax rate:

	Years Ended December 31,
	2017			2016			2015
Tax at federal statutory tax rate		(34	)%		34	%		(34	)%
State income tax, net of federal tax benefit		—			2	%		0	%
State Apportionment		—			(7	)%		0	%
Tax credits (net)		(8	)%		(32	)%		(7	)%
Federal statutory rate reduction		51	%		—			—
Deferred tax assets (utilized) not benefited		(10	)%		(15	)%		37	%
Stock-based compensation		—			7	%		2	%
NOL Expiration		—			9	%		2	%
Other		1	%		2	%		0	%
Total		0	%		0	%		0	%

	Years Ended December 31,
	2017			2016		2015
United States	$	(127,235	)	$	16,453	$	(37,501	)
Foreign		(555	)		—		—
Total	$	(127,790	)	$	16,453	$	(37,501	)

Deferred tax assets reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of the Company’s deferred tax assets and liabilities were as follows (in thousands):

	As of December 31,
	2017			2016			2015
Deferred tax assets:
Net operating loss ("NOL") carryforwards	$	98,630		$	146,961		$	153,251
Tax credits		64,185			46,998			38,742
Liability related to sale of future royalties		24,593			—			—
Reserves and accruals		10,524			10,258			12,899
Capitalized R&D		6,432			11,675			13,150
Depreciation and amortization		546			766			769
Total deferred tax assets		204,910			216,658			218,811
Less: Valuation allowance		(204,910	)		(216,658	)		(218,811	)
Net deferred tax assets	$	—		$	—		$	—

At December 31, 2017, federal NOL carryforwards were $382.8 million and apportioned state NOL carryforwards before federal benefits were $244.8 million. If not utilized, the federal and state operating loss carryforwards will begin to expire in various amounts beginning 2022 and 2028, respectively.

At December 31, 2017, tax credits were $61.1 million and $14.7 million for federal and state income tax purposes, respectively and consisted of Research and Development Credits and Orphan Drug Credits. If not utilized, the federal carryforwards will expire in various amounts beginning in 2021. California based credit carryforwards do not expire.

Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Based upon the weight of available evidence, which includes the Company’s historical operating performance, reported cumulative net losses since inception, expected future losses, and difficulty in accurately forecasting the Company’s future results and an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets are recoverable, the Company maintained a full valuation allowance on the net deferred tax assets as of December 31, 2017, 2016, and 2015. The valuation allowance decreased by $11.7 million in 2017, decreased by $2.1 million in 2016, and increased by $13.9 million in 2015.

In general, under Section 382 of the Internal Revenue Code (“Section 382”), a corporation that undergoes an ‘ownership change’ is subject to limitations on its ability to utilize its pre-change net operating losses and tax credits to offset future taxable income. The Company does not believe it has experienced an ownership change since 2006. The Company expects a portion of its NOLs and tax credits from prior to 2007 will be subject to limitations under Section 382.

Activity related to the Company’s gross unrecognized tax benefits were (in thousands):

	Years Ended December 31,
	2017		2016
Balance at the beginning of the year	$	7,565	$	6,715
Decrease related to prior year tax positions		-		5
Increase related to current year tax positions		1,800		845
Balance at the end of the year	$	9,365	$	7,565

The significant jurisdictions in which the Company files income tax returns are the United States and California. The Company is subject to income tax examination for all fiscal years since inception. Included in the balance of unrecognized tax benefits as of December 31, 2017, 2016, and 2015 are $8.1 million, $6.3 million and $5.5 million of tax benefits, respectively, that, if recognized, would result in adjustments to other tax accounts, primarily deferred taxes.

Tax Reform

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a corporate tax rate decrease from 34% to 21% (the “Rate Reduction”) effective for tax years beginning after December 31, 2017. The Company reduced deferred tax assets at December 31, 2017 for the effect of the Rate Reduction. The Rate Reduction did not impact the Company's provision for income taxes for 2017 due to the full valuation allowance on deferred tax assets.

Staff Accounting Bulletin No. 118 ("SAB 118") was issued to address the application of US GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Act. The Company determined that $68.3 million of the reduction in deferred tax assets resulting from Rate Reduction was both provisional and a reasonable estimate at December 31, 2017. Additionally, the Company is still in the process of analyzing certain provisions of the Act including the application of new executive compensation limitation provisions under Internal Revenue Section 162(m). These items are subject to revisions from further analysis of the Tax Act and interpretation of any additional guidance issued by the U.S. Treasury Department, IRS, FASB, and other standard-setting and regulatory bodies.