NOTE 12. INCOME TAXES

The Company’s income before income tax benefit was $260.2 million for the year ended December 31, 2014. The Company’s loss before income tax expense was $42.5 million and $41.3 million for the years ended December 31, 2013 and 2012, respectively. Since inception, the Company has only generated pre-tax income (losses) in the United States and has not generated any pre-tax income (losses) outside the United States. Income tax benefit (expense) for the periods presented consisted of the following:


	Years Ended December 31,
	2014			2013			2012
Current:
Federal	$	(19,476	)	$	(7	)	$	(7	)
State		(1,496	)		(108	)		—

Total current		(20,972	)		(115	)		(7	)
Deferred:
Federal		36,917			—			—
State		313			—			—

Total deferred		37,230			—			—

Total income tax benefit (expense)	$	16,258		$	(115	)	$	(7	)

During 2014, the Company reduced its current Federal and state taxes payable by $17.0 million related to excess tax benefits from stock-based compensation, offsetting additional paid-in capital. The Company has unrecorded Federal and state excess stock-based compensation tax benefits of $81.4 million (tax-effected) as of December 31, 2014. These amounts will be credited to additional paid-in-capital when such amounts reduce cash taxes payable.

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,
	2014			2013			2012
Federal tax provision at statutory rate		35.0	%		35.0	%		35.0	%
State taxes (net of Federal benefit)		0.4	%		1.4	%		10.8	%
Orphan drug credit		—			—			0.3	%
Stock-based compensation		0.1	%		(0.2	%)		1.5	%
Non-deductible officer compensation		0.1	%		(1.8	%)		(1.9	%)
Change in valuation allowance		(40.5	%)		(52.1	%)		(45.5	%)
Research and development credits		(1.5	%)		17.1	%		—
Other		0.2	%		0.3	%		(0.2	%)

Effective income tax rate		(6.2	%)		(0.3	%)		0.0	%

The Company recorded an income tax benefit of $16.3 million for the year ended December 31, 2014. The provision for income taxes was lower than the tax computed at the U.S. Federal statutory rate due primarily to utilization of net operating loss and tax credit carryforwards and the release of the valuation allowance on a portion of the Company’s net deferred tax assets. 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.

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,
	2014			2013
Deferred tax assets:
Deferred revenue	$	1,005		$	6,073
Net operating loss carryforward		9,100			80,620
Stock-based compensation		26,000			21,257
Tax credits		12,098			22,616
Intangible assets		5,259			—
Accruals and reserves		15,247			10,544

Total deferred tax assets		68,709			141,110
Less: valuation allowance		(16,023	)		(120,807	)

Total net deferred tax assets		52,686			20,303

Deferred tax liabilities
Depreciation		(2,741	)		(2,674	)
Convertible Notes		(12,792	)		(17,629	)

Total deferred tax liabilities		(15,533	)		(20,303	)

Net deferred tax assets	$	37,153		$	—

Recorded as:
Net current deferred tax assets	$	21,987		$	5,541
Net non-current deferred tax assets		15,176			—
Net non-current deferred tax liabilities (included in “Other non-current liabilities”)		(10	)		(5,541	)

Net deferred tax assets	$	37,153		$	—

As of December 31, 2014, the Company had Federal net operating loss carryforwards for tax return purposes of approximately $160.6 million, which will expire in 2032 and 2033, if not utilized. Also, as of December 31, 2014, the Company had state net operating loss carryforwards for tax return purposes of approximately $240.4 million, which will expire at various dates between the years 2019 and 2033, if not utilized.

The Company has Federal research and development credit and Orphan Drug credit carryforwards of approximately $29.0 million and alternative minimum tax credits of approximately $4.0 million as of December 31, 2014. The Federal research tax credit carryforwards expire between the years 2024 through 2034, if not utilized. The alternative minimum tax credits do not expire. In addition, the Company has California research and development credit carryforwards of approximately $13.8 million as of December 31, 2014. The California research credits do not expire. On December 19, 2014 the Tax Increase Prevention Act of 2014 was signed, renewing the Federal research and development tax credit retroactive to January 1, 2014. 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, the Company recognized the benefit of the Federal research and development credit during the year ended December 31, 2014.

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, 2013, 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 changes occur, the utilization of net operating loss and credit carryforwards could be significantly reduced.

The valuation allowance decreased by $104.8 million in 2014, increased by $22.1 million in 2013 and decreased by $8.0 million in 2012.

The Company records a valuation allowance to reduce deferred tax assets to reflect the net amount that is more likely than not to be realized. Based upon the weight of available evidence at December 31, 2014, the Company determined that it was more likely than not that a portion of its deferred tax assets would be realizable and consequently released the valuation allowance against Federal and certain state net deferred tax assets and recorded a discrete tax benefit of $33.4 million during the fourth quarter of 2014. The decision to reverse a portion of the valuation allowance was made after management considered all available evidence, both positive and negative, including but not limited to the historical operating results, income or loss in recent periods, cumulative income in recent years, forecasted earnings, forecasted future taxable income, and significant risk and uncertainty related to forecasts. The release of the valuation allowance resulted in the recognition of certain deferred net tax assets and a decrease to income tax expense.

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


	December 31,
	2014			2013			2012
Balance as of beginning of year	$	5,955		$	4,602		$	3,936
Additions based on tax positions related to the current year		6,439			702			400
Additions based on tax position related to prior year		—			660			270
Decreases based on tax positions related to prior year		(27	)		(9	)		(4	)

Balance as of end of year	$	12,367		$	5,955		$	4,602

Approximately $6.7 million of the total gross unrecognized tax benefits at December 31, 2014, 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 2014, 2013, and 2012. Interest related to income tax matters accrued as of December 31, 2014 and 2013 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 Federal income tax returns were audited by the Internal Revenue Service for tax years 2008 and 2012 and resulted in no material adjustments. 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.

The future effective tax rate is subject to volatility and may be materially impacted by various internal and external factors. These factors may include, but are not limited to, the amount of income tax benefits and charges from: interpretations of existing tax laws; changes in tax laws and rates; future levels of research and development expenditures; changes in the mix of earnings in countries with differing statutory tax rates in which the Company may conduct business; changes in the valuation of deferred tax assets and liabilities; state income taxes; the tax impact of stock-based compensation; accounting for uncertain tax positions; closure of statute of limitations or settlement of tax audits; changes in estimates of prior years’ items; tax costs for acquisition-related items; changes in accounting standards; and overall levels of income before taxes.