INCOME TAXES

For the years ended December 31, 2017, 2016, and 2015, all of our profit or loss before income taxes was from U.S. operations. The income tax (benefit) expense consisted of the following (in thousands):



	Years Ended December 31,
	2017			2016			2015
Current:
Federal	$	2,180		$	—		$	—
State	5,375			4,259			2,058
Total current	$	7,555		$	4,259		$	2,058
Deferred:
Federal	$	(167,667	)	$	9,815		$	9,819
State	(10,754		)	(2,536		)	(4,812		)
Total deferred	$	(178,421	)	$	7,279		$	5,007
Total income tax (benefit) expense	$	(170,866	)	$	11,538		$	7,065

The reconciliation of the statutory U.S. federal income tax rate to our effective income tax rate was as follows:



	Years Ended December 31,
	2017		2016		2015
Statutory U.S. federal tax rate	35.0	%	35.0	%	35.0	%
State taxes, net of federal benefit	3.4		6.4		0.1
Impact of 2017 tax reform on deferred tax balance	4.8		—		—
Equity-based compensation expense	(1.0	)	34.0		0.4
Contingent consideration	4.5		69.9		4.7
Transaction costs	—		—		3.9
Other permanent items, net	(0.6	)	21.2		3.2
Tax credits	0.7		(32.3	)	(1.7	)
Write-down of acquired state net operating losses	—		114.2		—
Valuation allowance	(0.8	)	(115.2	)	(28.0	)
Other, net	0.2		(5.8	)	0.1
Effective tax rate	46.2	%	127.4	%	17.7	%

For the year ended December 31, 2017, we recognized an income tax benefit of $170.9 million, representing an effective tax rate of 46.2%. The difference between the expected statutory federal tax rate of 35.0% and the effective tax rate of 46.2% for the year ended December 31, 2017, was primarily attributable to the impact of the 2017 federal tax reform legislation, as discussed below, contingent consideration associated with Lumara Health, federal research and orphan drug tax credits generated during the year, and the impact of state income taxes, partially offset by equity-based compensation expenses and an increase to our valuation allowance.

On December 22, 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”), was enacted. The 2017 Tax Act includes significant changes to the U.S. corporate income tax system, including a reduction of the federal corporate income tax rate from 35.0% to 21.0%, effective January 1, 2018. Deferred tax assets and liabilities are measured using enacted rates in effect for the year in which those temporary differences are expected to be recovered or settled. As a result of the reduction in the federal tax rate from 35.0% to 21.0%, we revalued our ending net deferred tax liabilities at December 31, 2017 and recognized a provisional $17.6 million tax benefit. We are still assessing the implications of the 2017 Tax Act on both a federal and state level, as further discussed below.

On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the 2017 Tax Act. SAB 118 allows us to record provisional amounts during a measurement period which is similar to the measurement period used when accounting for business combinations. We have recognized the provisional tax impacts related to the revaluation of deferred tax assets and liabilities and included these amounts in our consolidated financial statements for the year ended December 31, 2017. While we believe these estimates are reasonable, the ultimate impact may differ from these provisional amounts due to further review of the enacted legislation, changes in interpretations and assumptions we have made, and additional accounting and regulatory guidance that may be issued.

For the year ended December 31, 2016, we recognized income tax expense of $11.5 million representing an effective tax rate of 127.4%. The difference between the expected statutory federal tax rate of 35.0% and the 127.4% effective tax rate for 2016 was primarily attributable to the impact of contingent consideration associated with Lumara Health, equity-based compensation expenses and other permanent items, including meals and entertainment expense, officers compensation and Makena-related expenses, partially offset by the benefit of the federal research and development and orphan drug tax credits generated during the year. The effective tax rate for the year-ended December 31, 2016 reflected the significance of these permanent differences in relation to the pre-tax income for the year-ended December 31, 2016. As a result of state tax planning during 2016, we analyzed the acquired state net operating losses (“NOLs”) and determined that a significant portion were not utilizable and should be written down. This write-down was offset with a decrease in the valuation allowance as we had previously determined that it was more likely than not that these NOLs would not be utilized.

For the year ended December 31, 2015, we recognized income tax expense of $7.1 million representing an effective tax rate of 17.7%. The difference between the statutory tax rate and the effective tax rate was primarily attributable to a valuation allowance release related to certain deferred tax assets, partially offset by non-deductible transaction costs associated with the acquisition of CBR, and non-deductible contingent consideration expense associated with Lumara Health.

See Note C, “Business Combinations,” for more information on the CBR acquisition.

Deferred tax assets and deferred tax liabilities are recognized based on temporary differences between the financial reporting and tax basis of assets and liabilities using future enacted rates. A valuation allowance is recorded against deferred tax assets if it is more likely than not that some or all of the deferred tax assets will not be realized. The components of our deferred tax assets and liabilities were as follows (in thousands):



	December 31,
	2017			2016
Assets
Net operating loss carryforwards	$	61,070		$	116,275
Tax credit carryforwards	15,892			9,415
Deferred revenue	3,420			1,811
Equity-based compensation expense	6,401			8,045
Capitalized research & development	7,872			18,284
Reserves	4,273			8,018
Contingent consideration	1,406			4,140
Other	6,777			9,769
Valuation allowance	(5,597		)	(1,429		)
Liabilities
Property, plant and equipment depreciation	(1,501		)	(2,145		)
Intangible assets and inventory	(107,906		)	(367,667		)
Debt instruments	(15,744		)	(1,040		)
Other	(290		)	(542		)
Net deferred tax liabilities	$	(23,927	)	$	(197,066	)

The valuation allowance increased by approximately $4.2 million for the year ended December 31, 2017, which was primarily attributable to the establishment of a valuation allowance on certain state NOL and credit carryforwards. During the year ended December 31, 2017, we entered into a three-year cumulative loss position and established a valuation allowance on certain deferred tax assets to the extent that our existing taxable temporary differences would not be available as a source of income to realize the benefits of those deferred tax assets. At December 31, 2017, the valuation allowance related primarily to certain of our state NOL and credit carryforwards.

At December 31, 2017, we had federal and state NOL carryforwards of approximately $265.8 million and $90.9 million, respectively, of which $165.5 million and $16.6 million federal and state NOL carryforwards, were acquired as part of the Lumara Health transaction, respectively. Also included in the state NOL carryforwards at December 31, 2017 were $10.9 million of state NOL carryforwards which were acquired as part of the CBR transaction. The state NOL carryforwards acquired from Lumara Health are subject to a full valuation allowance as it is not more likely than not that they will be realized. The federal and state NOLs expire at various dates through 2037. We have federal tax credits of approximately $14.8 million to offset future tax liabilities of which $1.5 million were acquired as part of the Lumara Health transaction. We have state tax credits of $1.4 million to offset future tax liabilities. These federal and state tax credits will expire periodically through 2037 if not utilized.

Utilization of our NOLs and research and development (“R&D”) credit carryforwards may be subject to a substantial annual limitation due to ownership change limitations that have occurred previously or that could occur in the future in accordance with Section 382 of the Internal Revenue Code of 1986 (“Section 382”) as well as similar state provisions. These ownership changes may limit the amount of NOL and R&D credit carryforwards that can be utilized annually to offset future taxable income and taxes, respectively. In general, an ownership change as defined by Section 382 results from transactions increasing the ownership of certain shareholders or public groups in the stock of a corporation by more than 50% over a three-year period. Since our formation, we have raised capital through the issuance of capital stock on several occasions. These financings, combined with the purchasing shareholders’ subsequent disposition of those shares, could result in a change of control, as defined by Section 382. We conducted an analysis under Section 382 to determine if historical changes in ownership through December 31, 2017 would limit or otherwise restrict our ability to utilize these NOL and R&D credit carryforwards. As a result of this analysis, we do not believe there are any significant limitations on our ability to utilize these carryforwards. The NOLs and tax credits acquired from Lumara health are subject to restrictions under Section 382. These restricted NOLs and credits may be utilized subject to an annual limitation. While we identified two ownership changes associated with the attributes acquired as part of the Lumara Health transaction and determined these attributes are subject to an annual limitation, we do not expect the limitations to result in expiration of these attributes prior to utilization. However, future changes in ownership after December 31, 2017 could affect the limitation in future years and any limitation may result in expiration of a portion of the NOL or R&D credit carryforwards before utilization.

Unrecognized tax benefits represent uncertain tax positions for which reserves have been established. A reconciliation of our changes in unrecognized tax benefits is as follows (in thousands):



	Years Ended December 31,
	2017			2016			2015
Unrecognized tax benefits at the beginning of the year	$	13,330		$	12,695		$	—
Additions based on tax positions related to the current year	574			300			12,695
Additions for tax positions from prior years	340			379			—
Subtractions for federal tax reform	(3,296		)	—			—
Subtractions for tax positions from prior years	(78		)	(44		)	—
Unrecognized tax benefits at the end of the year	$	10,870		$	13,330		$	12,695

Included in the balance of unrecognized tax benefits as of December 31, 2017, 2016, and 2015 are $10.7 million, $13.0 million, and $12.4 million, respectively, of unrecognized tax benefits that would impact the effective tax rate if recognized.

Our unrecognized tax benefits as of December 31, 2017 decreased by $2.5 million as compared to December 31, 2016 primarily due to the change in the federal tax rate, which reduced the future value of our federal NOLs and the corresponding value of the unrecognized tax benefits related to those NOLs. This decrease was partially offset by tax reserves established on R&D tax credits.

Our unrecognized tax benefits as of December 31, 2016 increased by $0.6 million as compared to December 31, 2015 primarily due to tax reserves established on R&D tax credits.

During the year ended December 31, 2015, we completed studies of our historical R&D tax credits and other tax attributes, including those acquired in connection with the Lumara Health transaction. Our unrecognized tax benefits as of December 31, 2015 were attributable to the results of those studies, which identified uncertain tax positions of $12.7 million related to federal and state R&D credits and NOL carryforwards. These amounts were recorded as a reduction to our deferred tax assets as of December 31, 2015. A valuation allowance was recorded against these attributes at December 31, 2014, therefore there was no impact to income tax expense as a result of recording the unrecognized tax benefits during the year ended December 31, 2015.

We have recorded minimal interest or penalties on unrecognized tax benefits since inception. We recognize both accrued interest and penalties related to unrecognized tax benefits in income tax expense. We do not expect our unrecognized tax benefits to change significantly in the next 12 months.

The statute of limitations for assessment by the Internal Revenue Service (the “IRS”) and most state tax authorities is closed for tax years prior to December 31, 2014, although carryforward attributes that were generated prior to tax year 2014 may still be adjusted upon examination by the IRS or state tax authorities if they either have been or will be used in a future period. We file income tax returns in the U.S. federal and various state jurisdictions. There are currently no federal or state audits in progress.