NOTE 10. INCOME TAXES

The Company’s net loss before income tax (expense) benefit was $42.5 million, $41.3 million and $43.2 million for the years ended December 31, 2013, 2012 and 2011, respectively. Since inception, the Company has only generated pre-tax income (losses) in the U.S. and has not generated any pre-tax income (losses) outside the U. S. Income tax (expense) benefit for the periods presented consisted of the following:


	Years Ended December 31,
	2013			2012			2011
Current:
Federal	$	(7	)	$	(7	)	$	4,309
State		(108	)		—			22

Total current		(115	)		(7	)		4,331
Deferred:
Federal		—			—			—
State		—			—			—

Total deferred		—			—			—

Total income tax (expense) benefit	$	(115	)	$	(7	)	$	4,331

A reconciliation of the statutory Federal income tax rate of 35% to the Company’s effective income tax rates is as follows:


	Years Ended December 31,
	2013			2012			2011
Federal tax provision at statutory rate		35.00	%		35.00	%		35.00	%
State taxes (net of Federal benefit)		1.43	%		10.81	%		2.27	%
Change in tax reserve		(2.31	%)		(0.06	%)		(0.94	%)
Orphan drug credit		—			0.25	%		(0.70	%)
Stock-based compensation		(0.25	%)		1.50	%		0.06	%
Non-deductible officer compensation		(1.79	%)		(1.86	%)		0.20	%
Change in valuation allowance		(52.09	%)		(45.48	%)		(29.94	%)
Research and development credits		19.37	%		—			7.05	%
Net proceeds from stockholder securities law settlement		—			—			(2.43	%)
Other		0.37	%		(0.19	%)		(0.53	%)

Benefit (provision) for taxes		(0.27	)%		(0.03	%)		10.04	%

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the tax basis of assets and liabilities. Significant components of the Company’s deferred tax assets for Federal and state income taxes are follows:


	December 31,
	2013			2012
Deferred tax assets:
Deferred revenue	$	6,073		$	15,491
Net operating loss carry forward		80,620			72,232
Stock-based compensation		21,257			12,721
Research and development credits		22,616			13,897
Depreciation, amortization and other		—			109
Accruals and reserves		10,544			6,530

Total deferred tax assets		141,110			120,980
Less: valuation allowance		(120,807	)		(98,671	)

Total net deferred tax assets		20,303			22,309

Deferred tax liabilities
Depreciation, amortization, and other		(2,674	)		—
Convertible Notes		(17,629	)		(22,309	)

Total deferred tax liabilities		(20,303	)		(22,309	)

Net deferred tax assets	$	—		$	—

Recorded as:
Net current deferred tax assets (included in “Prepaid expenses and other current assets”)	$	5,541		$	3,800
Net non-current deferred tax assets		—			—
Net current deferred tax liabilities		—			—
Net non-current deferred tax liabilities (included in “Other non-current liabilities”)		(5,541	)		(3,800	)

Net deferred tax assets	$	—		$	—

As of December 31, 2013, the Company had Federal net operating loss carryforwards for tax return purposes of approximately $334.4 million, which will expire between 2031 and 2033, if not utilized. Also, as of December 31, 2013, the Company had state net operating loss carryforwards for tax return purposes of approximately $268.0 million, which will expire at various dates between the years 2015 and 2033, if not utilized. Included in these amounts are unrealized Federal and state net operating loss deductions resulting from stock option exercises of approximately $134.1 million and $63.4 million, respectively. The benefit of these unrealized stock option-related deductions has not been included in the deferred tax assets table above and will be recognized as a credit to additional paid-in capital when realized.

The income tax expense for the years ended December 31, 2013 and 2012 was not significant. The difference in the effective tax rate for 2013 as compared to 2012 is primarily attributable to state income tax expense. The difference in the effective tax rate for 2012 as compared to 2011 is primarily attributable to the benefit in 2011 due to the ability to carry back the current year Federal net operating loss to the prior two tax years.

The income tax benefit for 2011 was approximately $4.3 million, which was primarily due to the Company’s ability to carry back the current year Federal net operating loss to the prior two tax years.

Due to the Company’s lack of earnings history, the net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance increased by $22.1 million in 2013, decreased by $8.0 million in 2012 and increased by $12.9 million in 2011.

Based upon the weight of available evidence, which includes the Company’s historical operating performance, reported cumulative net losses since inception and current year net loss, the Company has established and continues to maintain a full valuation allowance against its deferred tax assets as the Company does not currently believe that realization of those assets is more likely than not.

The following table summarizes activity related to the Company’s gross unrecognized tax positions:


	December 31,
	2013			2012			2011
Balance as of beginning of year	$	4,602		$	3,936		$	4,128
Additions based on tax positions related to the current year		702			400			500
Additions based on tax position related to prior year		660			270			109
Decreases based on tax positions related to prior year		(9	)		(4	)		(801	)

Balance as of end of year	$	5,955		$	4,602		$	3,936

Approximately $0.6 million of the total gross unrecognized tax benefits at both December 31, 2013 and 2012, respectively, if recognized, would affect the effective tax rate. The Company does not anticipate a material change in unrecognized tax benefits during the next twelve months.

Interest and/or penalties related to income tax matters are recognized as a component of income tax expense as incurred. The interest expense related to uncertain tax positions in the income tax expense line of the Company’s consolidated statements of operations was not significant during 2013, 2012, and 2011. Interest related to income tax matters accrued as of December 31, 2013 and 2012 was not significant.

As a result of the Company’s net operating loss and tax credit carryforwards, all of its tax years are subject to Federal and state examination. The Company’s 2012 Federal income tax returns are currently under audit by the Internal Revenue Service, or IRS. The Company was audited by the IRS for the tax year of 2008. The audit was closed in 2011 with no adjustment. The Company’s 2009 and 2010 California income tax returns are currently under audit by the California tax authorities. The Company believes that it has adequately provided for any reasonable foreseeable outcomes related to its Federal and California income tax returns.

Federal and state tax laws impose substantial restrictions on the utilization of net operating loss and credit carryforwards in the event of an “ownership change” for tax purposes, as defined in IRC Section 382. The Company completed Section 382 studies through December 31, 2012, and concluded that ownership changes occurred in 2004, 2007 and 2010. The ownership changes did not result in a reduction of its net operating loss or in its research and development credits expiring unused. If additional ownership change occurs, the utilization of net operating loss and credit carryforwards could be significantly reduced.

The Company has Federal research and development credit and Orphan Drug credit carryforwards of approximately $22.2 million as of December 31, 2013. The Federal tax credit carryforwards expire between the years 2024 through 2033, if not utilized. In addition, the Company has California research and development credit carryforwards of approximately $7.8 million as of December 31, 2013. The California research credits do not expire. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed, renewing the Federal research and development tax credit retroactive to January 1, 2012. ASC 740-10-45-15, “Income Taxes,” requires that the effects of a change in tax laws or rates be recognized in the period that includes the enactment date; consequently, we recognized the benefit of the Federal research and development credit during the year ended December 31, 2013.