Income Taxes

The Company’s loss before income taxes was $39.2 million and $23.8 million for the years ended December 31, 2019 and 2018, respectively and was generated entirely in the United States. The Company did not record current or deferred income tax expense or benefit during the years ended December 31, 2019 and 2018.

A reconciliation of income tax expense (benefit) to the amount computed by applying the statutory federal income tax rate to the loss from operations is summarized for the years ended December 31, 2019 and 2018, respectively, as follows (in thousands):



	Year Ended December 31,
	2019			2018
Income tax benefit at statutory rate	$	(8,242	)	$	(5,008	)
State income tax, net of federal benefit	(3,783		)	(1,593		)
Permanent items	16			3
Fair value adjustments	—			15
Non-deductible interest expense	—			706
Stock-based compensation	56			45
Orphan drug credit	(925		)	(475		)
Research and development credits	(763		)	(274		)
Uncertain tax positions	548			222
Tax Cuts and Jobs Act	—			(15		)
Change in state rate	(34		)	—
Change in valuation allowance	13,179			6,426
Other	(52		)	(52		)
	$	—		$	—

Significant components of the Company’s deferred tax assets as of December 31, 2019 and 2018 are shown below:



	As of December 31,
	2019			2018
Deferred tax assets:
Net operating loss carryforwards	$	42,872		$	31,744
Research and development and orphan drug credits	6,212			4,615
Accrued expenses	519			332
Intangibles	60			69
Operating lease liabilities	545			—
Other, net	322			54
Total deferred tax assets	50,530			36,814

Deferred tax liabilities:
Operating lease right-of-use assets	(527		)	—
Property and equipment, net	(28		)	(18		)
Total deferred tax liabilities	(555		)	(18		)

Net deferred tax assets before valuation allowance	49,975			36,796
Valuation allowance	(49,975		)	(36,796		)
Net deferred tax assets	$	—		$	—

As of December 31, 2019 and 2018, management assessed the realizability of net deferred tax assets and evaluated the need for a valuation allowance against the net deferred tax assets. This evaluation utilizes the framework contained in ASC 740, Income Taxes, whereby management considers all available positive and negative evidence as of the balance sheet date to determine whether all or some portion of the Company’s net deferred tax assets will be realized. Under this guidance, a valuation allowance must be established for net deferred tax assets when it is more-likely-than-not (a probability level of more than 50%) that the asset will not be realized.

Management followed the guidance in ASC 740, which states that “a cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome” and concluded that the Company’s net deferred tax assets were not realizable as of December 31, 2019 and 2018. Accordingly, a valuation allowance of $50.0 million and $36.8 million has been recorded to offset the net deferred tax assets. The change in valuation allowance for the years ended December 31, 2019 and 2018 was an increase of $13.2 million and an increase of $6.4 million, respectively.

At December 31, 2019, the Company had federal and state net operating loss (“NOL”) carryforwards of $149.0 million, and $153.4 million, respectively. The federal NOLs generated prior to 2018 may be used to offset up to 100% of future taxable income and will begin to expire in 2022, unless previously utilized. The federal NOL generated post-2017 of $57.4 million will be available to offset up to 80% of future taxable income and may be carried forward indefinitely. The Pennsylvania NOLs may be used to offset 40% of future taxable income and will begin to expire in 2029, unless previously utilized.

At December 31, 2019, the Company has federal and Pennsylvania research and development tax credit carryforwards totaling $3.8 million and $0.4 million, respectively. The federal and Pennsylvania research and development tax credit carryforwards will begin to expire in 2028 and 2029, respectively, unless previously utilized.

At December 31, 2019, the Company also has federal orphan drug credit carryforwards of $4.2 million, which will begin to expire in 2036, unless previously utilized.

Through December 31, 2019, the Company has generated a combination of research and development credits and orphan drug credits. Certain of these credits were derived from tax credit studies to document the qualified activities and certain other credits were not derived from studies. For the credits that were calculated through a study, the IRS, on audit, may disagree with the amount of credits calculated. When studies are ultimately performed for the other credits, they may result in an adjustment to those specific credits.

Under the Internal Revenue Code, the utilization of a corporation’s net operating loss and tax credit carryforwards may be limited following a greater than 50% change in ownership over a three-year period. Any unused annual limitation may be carried forward to future years for the balance of the net operating loss and tax credit carryforward period. Under these rules, prior ownership changes may have created a limitation in the Company’s ability to use certain tax carryforwards on a yearly basis. Additionally, certain state operating losses may also be limited, including Pennsylvania, which limits net operating loss carryforward utilization to 40% of apportioned taxable income.

The Company applies the two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount, which is more than 50% likely of being realized upon ultimate settlement. Income tax positions must meet a more likely than not recognition threshold at the effective date to be recognized upon the adoption of ASC 740 and in subsequent periods. This interpretation also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

The Company files income tax returns in the United States federal jurisdiction and various state jurisdictions. Tax years 2016 and forward remain open for examination for federal tax purposes and tax years 2016 and forward remain open for examination for the Company’s more significant state tax jurisdictions. To the extent utilized in future years’ tax returns, net operating loss carryforwards at December 31, 2019 will remain subject to examination until the respective tax year is closed.

The following table summarizes the activity related to the Company’s gross unrecognized tax benefits for the years ended December 31, 2019 and 2018 (in thousands):



	Year Ended December 31
	2019		2018
Gross unrecognized tax benefits at the beginning of the year	$	1,809	$	1,293
Increases related to current year positions	645		362
Increases related to prior year positions	106		154
Decreases related to prior year positions	—		—
Expiration of unrecognized tax benefits	—		—
Gross unrecognized tax benefits at the end of the year	$	2,560	$	1,809

Due to the Company's valuation allowance, none of the unrecognized tax benefits, if recognized, would affect the Company's effective tax rate.

As of December 31, 2019, and 2018, the Company had unrecognized tax benefits of $2.6 million and $1.8 million, respectively. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. During the years ended December 31, 2019 and 2018, the Company did not accrue any interest and penalties on uncertain tax positions. The Company does not expect its unrecognized tax benefits to change significantly within the next 12 months.