INCOME TAXES
The Company accounts for income taxes under ASC 740. Deferred income tax assets and liabilities are determined based upon differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
The following table provides a reconciliation between income taxes computed at the federal statutory rate of 34% and the provision for income taxes (in thousands):
|
| | | | | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Federal income taxes at 34% | $ | (18,947 | ) | | $ | (16,334 | ) | | $ | (10,946 | ) |
State income tax, net of federal benefit | — |
| | (1 | ) | | (1,821 | ) |
Tax effect on nondeductible expenses | 3,389 |
| | 1,650 |
| | 341 |
|
Research credits | (8,125 | ) | | (3,538 | ) | | (676 | ) |
Rate change | — |
| | 267 |
| | — |
|
Change in valuation allowance | 5,133 |
| | 14,996 |
| | 13,084 |
|
Reserve for uncertain tax positions | 1,451 |
| | 2,883 |
| | — |
|
Tax Cuts and Jobs Act | 17,334 |
| | — |
| | — |
|
Other | (235 | ) | | 77 |
| | 18 |
|
Income tax expense | $ | — |
| | $ | — |
| | $ | — |
|
Significant components of the Company’s net deferred tax assets are as follows (in thousands):
|
| | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 |
Deferred tax assets: | | | |
Net operating losses | $ | 26,364 |
| | $ | 27,309 |
|
Research credits | 10,232 |
| | 3,646 |
|
Intangibles | 265 |
| | 466 |
|
Other | 1,722 |
| | 2,030 |
|
Total deferred tax assets | 38,583 |
| | 33,451 |
|
Less valuation allowance | (38,583 | ) | | (33,451 | ) |
Income tax expense | $ | — |
| | $ | — |
|
At December 31, 2017, the Company had federal and state net operating loss carryforwards of approximately $122.5 million and $81.5 million, respectively. The federal and state loss carryforwards begin to expire in 2033, unless previously utilized. The Company also has federal research and development and orphan drug credit carryforwards totaling $12.5 million and state research and development credit carryforwards totaling $1.6 million. The federal research and development credit and orphan drug credit carryforwards begin to expire in 2033, unless previously utilized. The state research and development credit carryforwards begin to expire in 2018.
Management assesses the available positive and negative evidence to estimate if sufficient future taxable income will be generated to use the existing deferred tax assets. Based on the weight of all evidence, including a history of operating losses, management has determined that it is more likely than not that the net deferred tax assets will not be realized. A valuation allowance of $38.6 million and $33.5 million as of December 31, 2017 and 2016, respectively, has been established to offset the deferred tax assets as realization of such assets is uncertain.
Future utilization of the Company’s net operating loss and research and development credits carryforwards to offset future taxable income may be subject to an annual limitation, pursuant to Internal Revenue Code (IRC) Sections 382 and 383, as a result of ownership changes that may have occurred or that could occur in the future. An ownership change occurs when a cumulative change in ownership of more than 50% occurs within a three-year period. The Company has not completed an IRC Section 382/383 analysis regarding the limitation of net operating loss and research and development credit carryforwards.
The Tax Cuts and Jobs Act was enacted on December 22, 2017. The Act reduces the US federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and creates new taxes on certain foreign sourced earnings. At December 31, 2017, the Company has not completed accounting for the tax effects of enactment of the Act; however, in certain cases, as described below, the Company has made a reasonable estimate of the effects on its existing deferred tax balances. For items for which the Company was able to determine a reasonable estimate, it recognized a provisional amount of $17.3 million which was offset by a corresponding reduction to the valuation allowance. In all cases, the Company will continue to make and refine its calculations as additional analysis is completed. In addition, its estimates may also be affected as the Company gains a more thorough understanding of the tax law.
The Company recognizes a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more likely than not recognition at the effective date to be recognized. At December 31, 2017 and 2016, the unrecognized tax benefits recorded were approximately $10.8 million and $4.6 million, respectively. Approximately $8.6 million of the unrecognized tax benefits would reduce the Company's annual effective tax rates, if recognized, subject to the valuation allowances. The Company does not anticipate a significant change in the unrecognized tax benefits within the next 12 months.
A reconciliation of the beginning and ending amount of gross unrecognized tax benefits for 2017, 2016 and 2015 is as follows (in thousands):
|
| | | | | | | | | | | |
| Years Ended December 31, |
| 2017 | | 2016 | | 2015 |
Balance as of the beginning of the year | $ | 4,642 |
| | $ | 356 |
| | $ | 108 |
|
Increases related to current year tax positions | 3,965 |
| | 921 |
| | 248 |
|
Increases related to prior year tax positions | 2,149 |
| | 3,365 |
| | — |
|
Balance as of the end of the year | $ | 10,756 |
| | $ | 4,642 |
| | $ | 356 |
|
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 the United States and state jurisdictions where applicable. There are currently no pending income tax examinations. The Company’s tax years from inception in 2012 are subject to examination by the federal and state tax authorities due to the carryforward of unutilized net operating losses and research and development credits. The Company’s practice is to recognize interest and penalties related to income tax matters in income tax expense. The Company has not recognized interest or penalties since inception.