Fulgent Genetics, Inc.

Note 11. Income Taxes

Provision for income taxes consists of U.S. federal and state income taxes. A deferred tax liability is recognized for all taxable temporary differences, and a deferred tax asset is recognized for all deductible temporary differences, operating losses and tax credit carryforwards. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized.

Prior to the Reorganization, Fulgent LLC was organized as a limited liability company and its members elected to have Fulgent LLC treated as a partnership for income tax purposes. All taxable income or loss and tax credits generally were reflected in the personal income tax returns of the Fulgent LLC’s members. Accordingly, no provision for federal and state income taxes was provided in the accompanying consolidated financial statements prior to the Reorganization. Upon completion of the Reorganization, the Company converted from a pass-through entity for tax purposes to a taxable entity. The change in tax status resulted in $417,000 income tax expense related to the recognition of a net state deferred tax asset of $86,000 and a net federal deferred tax liability of $503,000, which represents the temporary differences in existence on September 30, 2016 between the tax basis of the Company’s assets and liabilities and the amount reported in the financial statements. As of December 31, 2017 and 2016, the net state deferred tax asset was $90,000 and $54,000, respectively, and the net federal deferred tax asset (liability) was $36,000 and $(243,000), respectively.

The 2017 Tax Act, which was signed into law on December 22, 2017, has resulted in significant changes to the U.S. corporate income tax system. These changes include, among others, a federal statutory rate reduction from 35% to 21%, the elimination or reduction of certain domestic deductions and credits and limitations on the deductibility of interest expenses and executive compensation expenses. The 2017 Tax Act also transitions international taxation from a worldwide system to a modified territorial system and includes base erosion prevention measures on non-U.S. earnings. These changes are effective beginning in 2018. The Company accounts for changes in tax rates and tax laws in the period of enactment. As a result, for 2017, due to the reduction in the corporate income tax rate with the enactment of the 2017 Tax Act, the Company recorded a tax expense of $22,000 related to the revaluation of its net deferred tax assets. The Company has determined that the various other provisions of the 2017 Tax Act are not expected to have a material impact on the Company’s results of operations or financial condition, largely because of the amount of the Company’s net operating loss carryover and the Company has no unrepatriated foreign earnings.

Income tax expense (benefit) consisted of the following:

	Year Ended December 31,
	2017			2016
	(in thousands)
Current:
Federal	$	(599	)	$	616
State		(80	)		58
Total Current		(679	)		674
Deferred:
Federal		(300	)		295
State		(36	)		(49	)
Change in valuation allowance		—			—
Total Deferred		(336	)		246
Total income tax expense (benefit)	$	(1,015	)	$	920

Reconciliation of the difference between the federal statutory income tax rate and the effective income tax rate is as follows:

	Year Ended December 31,
	2017			2016

Tax provision at federal statutory rate		34.00	%		34.00	%
State taxes		0.78	%		1.98	%
Other		1.54	%		0.16	%
Impact of tax reform (1)		-0.02	%
Stock based compensation		-2.13	%
Recognition of pre-merger temporary differences					-19.51	%
LLC income not subject to corporate taxes					-37.23	%
Tax provision		34.17	%		-20.60	%
________________
(1) The effective tax rate for the year ended December 31, 2017 includes the Company’s estimate of the effect of the 2017 Tax Act, which primarily relates to the remeasurment of existing deferred taxes as a result of the change to the U.S. federal corporate income tax rate.

The following table summarizes the elements of the deferred tax assets (liabilities):

	Year Ended December 31,
	2017			2016
	(in thousands)
Deferred tax assets
Accrued vacation and other accrued expenses	$	96		$	69
Provision for bad debts		65			54
Net operating losses		148
Stock based compensation		594			603
Unrealized loss on investments		37			58
State income taxes		6			20
Equity Method Investment		118
Gross deferred tax assets		1,064			804
Less: Valuation allowance		(118	)		-
Net deferred tax assets		946			804
Deferred tax liabilities
Depreciation		820			993
Total deferred tax liabilities		820			993
Net deferred tax assets (liabilities)	$	126		$	(189	)

During 2017 the Company recorded a deferred tax asset related to its equity method investment in FF Gene Biotech. When realized, the asset will generate a capital loss which may only be used to offset capital gain income. The Company does not currently have any capital gain income and has therefore recorded a full valuation allowance against this asset.

Uncertain Tax Positions

The Company is subject to income taxation by the United States government and certain states in which the Company's activities give rise to an income tax filing requirement. The Company does not have income tax filing requirements in any foreign jurisdiction, nor are any taxes withheld from income taxes withheld from foreign sales. As of December 31, 2017, there were no pending tax audits in any jurisdiction.

There were no tax-related interest or penalties accrued at December 31, 2017 and 2016.

While the Company believes it has adequately provided for all tax positions, amounts asserted by taxing authorities could differ from the Company's accrued positions. Accordingly, additional provisions on federal, state and foreign tax-related matters could be recorded in future periods as revised estimates are settled or otherwise resolved.