INCOME TAXES

For the years ended December 31, 2018, 2017, and 2016, all of our profit or loss before income taxes was from U.S. operations. The income tax expense (benefit) consisted of the following (in thousands):



	Years Ended December 31,
	2018			2017			2016
Current:
Federal	$	(1,136	)	$	2,162		$	—
State	1,469			5,358			4,169
Total current	$	333		$	7,520		$	4,169
Deferred:
Federal	$	42,886		$	(172,048	)	$	11,208
State	(3,565		)	(10,726		)	(2,206		)
Total deferred	$	39,321		$	(182,774	)	$	9,002
Total income tax expense (benefit)	$	39,654		$	(175,254	)	$	13,171

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



	Years Ended December 31,
	2018		2017		2016
Statutory U.S. federal tax rate	21.0	%	35.0	%	35.0	%
State taxes, net of federal benefit	4.7		3.3		5.4
Impact of 2017 tax reform on deferred tax balance	—		4.6		—
Equity-based compensation expense	(1.5	)	(0.8	)	16.2
Contingent consideration	7.2		4.4		41.5
Other permanent items, net	(1.4	)	(0.5	)	11.9
Tax credits	6.2		0.7		(19.2	)
Write-down of acquired state net operating losses	—		—		67.7
Valuation allowance	(67.4	)	(0.8	)	(68.3	)
Other, net	0.6		0.2		(3.9	)
Effective tax rate	(30.6	)%	46.1	%	86.3	%

For the year ended December 31, 2018, we recognized income tax expense of $39.7 million, representing an effective tax rate of (30.6)%. The difference between the expected statutory federal tax rate of 21.0% and the effective tax rate of (30.6)% for the year ended December 31, 2018, was primarily attributable to the establishment of a valuation allowance on net deferred tax assets other than refundable AMT credits, the impact of non-deductible stock compensation and other non-deductible expenses, partially offset by a benefit from contingent consideration associated with Lumara Health, state income taxes and orphan drug tax credits. We have established a valuation allowance on our deferred tax assets other than refundable credits 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. The valuation allowance on our deferred tax assets, other than refundable AMT credits, increased during the year ended December 31, 2018 primarily because the deferred tax liabilities associated with the CBR business, which was reclassified to discontinued operations and sold during the year ended December 31, 2018, are no longer available as a source of income to realize the benefits of the net deferred tax assets.

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.

On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which allowed us to record provisional amounts for the impact of the 2017 Tax Act during a measurement period which is similar to the measurement period used when accounting for business combinations. During the year ended December 31, 2018, we completed our accounting for the enactment date income tax effects of the 2017 Tax Act in accordance with SAB 118 and recorded immaterial adjustments as a result.

For the year ended December 31, 2017, we recognized an income tax benefit of $175.3 million representing an effective tax rate of 46.1%. The difference between the expected statutory federal tax rate of 35.0% and the 46.1% effective tax rate for 2017 was primarily attributable to the impact of the 2017 federal tax reform legislation, as discussed above, 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.

For the year ended December 31, 2016, we recognized income tax expense of $13.2 million representing an effective tax rate of 86.3%. The difference between the statutory tax rate and the effective tax rate 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, officer 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.

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,
	2018			2017
Assets
Net operating loss carryforwards	$	46,888		$	60,308
Tax credit carryforwards	24,290			15,577
Capital loss carryforwards	20,896			—
Interest expense carryforwards	4,318			—
Equity-based compensation expense	5,931			5,873
Capitalized research & development	4,635			7,872
Intangible assets	12,565			—
Reserves	2,683			3,342
Contingent consideration	87			1,406
Other	5,389			5,971
Valuation allowance	(113,278		)	(4,740		)
Liabilities
Property, plant and equipment depreciation	(614		)	(198		)
Intangible assets and inventory	—			(32,406		)
Debt instruments	(12,489		)	(15,744		)
Other	(41		)	(141		)
Net deferred tax assets	$	1,260		$	47,120

The valuation allowance increased by approximately $108.5 million for the year ended December 31, 2018. We have established a valuation allowance on our deferred tax assets other than refundable AMT credits 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. Our valuation allowance on our deferred tax assets, other than refundable AMT credits, increased during the year ended December 31, 2018, primarily because the deferred tax liabilities associated with the CBR business, which was reclassified to discontinued operations and sold during 2018, are no longer available as a source of income to realize the benefits of the net deferred tax assets.

At December 31, 2018, we had federal and state NOL carryforwards of approximately $199.0 million and $92.9 million, respectively, of which $123.1 million and $16.6 million federal and state NOL carryforwards, were acquired as part of the Lumara Health transaction, respectively. The federal and state NOLs expire at various dates through 2038. We have federal tax credits of approximately $23.4 million to offset future tax liabilities of which $2.3 million were acquired as part of the Lumara Health transaction. We have state tax credits of $1.2 million to offset future tax liabilities. These federal and state tax credits will expire periodically through 2038 if not utilized. We have a capital loss carryforward of $90.5 million from the sale of the CBR business that can only be used to offset future capital gains and expires in 2023. Our interest expense carryforward is $17.8 million, which may be carried forward indefinitely.

Utilization of our NOLs, interest expense carryforwards, 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 NOLs and interest expense carryforwards that can be utilized annually to offset future taxable income and may limit the amounts of R&D credit carryforwards that can be utilized annually to offset taxes. 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, 2018, based upon publicly available information as of December 31, 2018, would limit or otherwise restrict our ability to utilize these NOLs, interest expense, 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. 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. Future changes in ownership after December 31, 2018 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,
	2018		2017			2016
Unrecognized tax benefits at the beginning of the year	$	10,560	$	13,020		$	12,695
Additions based on tax positions related to the current year	12		574			300
Additions for tax positions from prior years	608		340			69
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	$	11,180	$	10,560		$	13,020

The amount of unrecognized tax benefits that would impact the effective tax rate if recognized is immaterial, as the majority of our uncertain tax positions relate to NOL and credit carryforwards, which, if recognized, are currently expected to require a full valuation allowance.

Our unrecognized tax benefits as of December 31, 2018 increased by $0.6 million as compared to December 31, 2017 primarily due to tax reserves established on R&D tax credits.

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 $0.3 million as compared to December 31, 2015 primarily due to tax reserves established on R&D tax credits.

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, 2015, although carryforward attributes that were generated prior to tax year 2015 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 audits in progress. We have two state audits in progress. We do not expect these audits to result in any material impact.