11. Income Taxes

During the years ended December 31, 2016, 2015 and 2014, the Company recorded no income tax benefits for the net operating losses incurred in each year due to its uncertainty of realizing a benefit from those items.

The domestic and foreign components of loss before income taxes are as follows:

 

		2016				2015				2014
		(in thousands)
Domestic		$	(57,799	)		$	(72,147	)		$	(35,818	)
Foreign			(79	)			(2,139	)			(660	)
Loss before income taxes		$	(57,878	)		$	(74,286	)		$	(36,478	)

A reconciliation of the U.S. federal statutory income tax rate to the Company’s effective income tax rate is as follows:

 

		Year Ended December 31,
		2016				2015				2014
Federal statutory income tax rate			(34.0	%)			(34.0	%)			(34.0	%)
Federal and state research and development tax credit			(2.9	)			(3.9	)			(1.9	)
State taxes, net of federal benefit			(3.9	)			(3.9	)			(4.0	)
Orphan drug tax credit			(1.3	)			(3.5	)			(3.2	)
Stock compensation expense			0.7				0.9				0.6
Nondeductible Australia research and development expenses			0.0				1.0				0.6
Other items			1.3				0.1				2.4
Change in deferred tax asset valuation allowance			40.1				43.3				39.5
Effective income tax rate			0.0	%			0.0	%			0.0	%

Net deferred tax assets as of December 31, 2016 and 2015 consisted of the following:

 

		December 31,
		2016				2015
		(in thousands)
Noncurrent deferred tax assets:
Capitalized research and development expenses			59,489				46,568
Net operating loss carryforwards			14,991				11,186
Tax credit carryforwards			14,297				11,570
Capitalized legal expenses			2,119				1,773
Stock-based compensation			6,027				2,780
Accrued expenses			783				648
Other temporary differences			14				16
Total noncurrent deferred tax assets			97,720				74,541
Total gross deferred tax assets			97,720				74,541
Valuation allowance			(97,720	)			(74,541	)
Net deferred tax assets		$	—			$	—

 

Changes in the valuation allowance for deferred tax assets during the years ended December 31, 2016, 2015 and 2014 related primarily to the increase in net operating loss carryforwards, capitalized research and development expenses and tax credit carryforwards and were as follows:

 

		Year Ended December 31,
		2016				2015				2014
		(in thousands)
Valuation allowance as of beginning of year		$	74,541			$	42,398			$	27,831
Decreases recorded as benefit to income tax provision			—				—				—
Increases recorded to income tax provision			23,179				32,143				14,567
Valuation allowance as of end of year		$	97,720			$	74,541			$	42,398

As of December 31, 2016, the Company had net operating loss carryforwards for federal and state income tax purposes of $49.1 million and $35.9 million, respectively, which begin to expire in 2026 and 2030, respectively. As of December 31, 2016, the Company did not record deferred tax assets of $12.8 million (gross) that were attributable to stock option exercises which will be recorded as an increase in additional paid in capital once they are realized in accordance with accounting for stock-based compensation awards. These deductions are not reflected in the federal and state net operating loss carryforwards and the capitalized research and development expense deferred tax assets in the amounts of $9.4 million, $7.2 million, and $3.4 million, respectively. As of December 31, 2016, the Company also had available tax credit carryforwards for federal and state income tax purposes of $13.1 million and $1.9 million, respectively, which begin to expire in 2026 and 2021, respectively. Utilization of the net operating loss carryforwards and tax credit carryforwards may be subject to a substantial annual limitation under Section 382 of the Internal Revenue Code of 1986 due to ownership changes that have occurred previously or that could occur in the future. These ownership changes may limit the amount of carryforwards that can be utilized annually to offset future taxable income.

In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain stockholders or public groups in the stock of a corporation by more than 50% over a three-year period. The Company has not conducted a study to assess whether a change of control has occurred or whether there have been multiple changes of control since inception due to the significant complexity and cost associated with such a study. If the Company has experienced a change of control, as defined by Section 382, at any time since inception, utilization of the net operating loss carryforwards or tax credit carryforwards would be subject to an annual limitation under Section 382, which is determined by first multiplying the value of the Company’s stock at the time of the ownership change by the applicable long-term tax-exempt rate, and then could be subject to additional adjustments, as required. Any limitation may result in expiration of a portion of the net operating loss carryforwards or tax credit carryforwards before utilization. Further, until a study is completed and any limitation is known, no amounts are being presented as an uncertain tax position.

As of December 31, 2016 and 2015, the Company’s gross deferred tax asset balance of $97.7 million and $74.5 million, respectively, was comprised principally of net operating loss carryforwards, capitalized research and development expenses and tax credit carryforwards. During the years ended December 31, 2016, 2015 and 2014, gross deferred tax assets increased due to additional net operating loss carryforwards, research and development tax credits generated and additional research and development expenses capitalized for tax purposes.

The Company has evaluated the positive and negative evidence bearing upon its ability to realize the deferred tax assets. Management has considered the Company’s history of cumulative net losses incurred since inception and its lack of commercialization of any products or generation of any revenue from product sales since inception and has concluded that it is more likely than not that the Company will not realize the benefits of the deferred tax assets. Accordingly, a full valuation allowance has been established against the deferred tax assets as of December 31, 2016 and 2015. Management reevaluates the positive and negative evidence at each reporting period.

 

The Company has not recorded any amounts for unrecognized tax benefits as of December 31, 2016 or 2015.

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 federal and state jurisdictions, where applicable. There are currently no pending income tax examinations. The Company’s tax years are still open under statute from 2013 to the present for federal income tax purposes and from 2012 to the present for state purposes. Earlier years may be examined to the extent that tax credit or net operating loss carryforwards are used in future periods. The Company’s policy is to record interest and penalties related to income taxes as part of its income tax provision.

The Company considers only the direct effects of windfall tax deductions.

The deferred tax assets above exclude $9.4 million and $7.2 million of gross ($3.2 million and $0.4 million tax effected) federal and state net operating losses, respectively, and $3.4 million of gross ($1.3 million tax effected) capitalized research and development related to tax deductions from the exercise of stock options subsequent to the adoption of the 2006 accounting standard on stock-based compensation. This amount represents an excess tax benefit and has not been included in the gross deferred tax assets. The Company will adopt ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, for the quarter ended March 31, 2017. As a result of adoption, the deferred tax assets associated federal and state net operating losses will increase by $9.4 million and $7.2 million gross ($3.2 million and $0.4 million tax effected), respectively, and capitalized research and development will increase by $3.4 million gross ($1.3 million tax effected). These amounts will be offset by a corresponding increase in the valuation allowance. The adoption of ASU No. 2016-09 will have no impact on the Company’s consolidated financial statements.