11. Income Taxes

At December 31, 2015, the Company had deferred tax assets of $120.8 million. Due to uncertainties surrounding the Company’s ability to generate future taxable income to realize these assets, a full valuation allowance has been established to offset the net deferred tax asset. Pursuant to Sections 382 and 383 of the Internal Revenue Code, or IRC, annual use of the Company’s net operating loss and credit carryforwards may be limited in the event a cumulative change in ownership of more than 50% occurs within a three-year period. The Company determined that such an ownership change occurred on December 29, 2006, as defined in the provisions of Section 382 of the IRC as a result of various stock issuances used to finance the Company’s operations. Such ownership change resulted in annual limitations on the utilization of tax attributes, including net operating loss carryforwards and tax credits. The Company estimates that $101.2 million of its net operating loss carryforwards were effectively eliminated under Section 382 for federal tax purposes. A portion of the remaining net operating losses limited by Section 382 become available each year. The Company also estimates that $12.2 million of its research and development credits and other tax credits were effectively eliminated under Section 383 for federal purposes. As a result of the Section 382 analysis completed during 2012, the Company has included in the deferred tax asset schedule the deferred tax assets for net operating losses of $83.1 million and tax credits of $19.9 million. The company’s Section 382 analysis was completed through December 31, 2011. There is a risk that additional changes in ownership could have occurred since that date. If a change in ownership were to have occurred, additional net operating loss and tax credit carryforwards could be eliminated or restricted. If eliminated, the related asset would be removed from the deferred tax asset schedule with a corresponding reduction in the valuation allowance.

The Company has historically filed its California income tax returns as doing business only in the state of California. Accordingly, all of its tax operating losses have been allocated to California. On December 31, 2015, the California Supreme Court overturned the decision of the California Court of Appeals in Gillette v. FTB. The California Supreme Court ruling, coupled with administrative guidance from the California Franchise Tax Board, has the effect of requiring California businesses to apportion their losses to California using a single sales factor, based on a market approach. Accordingly, the Company has preliminarily redetermined its California tax operating losses for 2013 through 2015 as if it were a multistate business subject to the California single sales factor market rules. Such an analysis has not been completed, and therefore the Company has adjusted its California net operating loss carryforwards and deferred tax assets to the state rate of zero in its financial statement disclosures. The California tax effect of the Company’s 2013 and 2014 net operating losses is reflected as an increase in unrecognized tax benefits in the table below.

Deferred income taxes result primarily from temporary differences between financial and tax reporting. Deferred tax assets and liabilities are determined based on the difference between the financial statement bases and the tax bases of assets and liabilities using enacted tax rates. A valuation allowance is established to reduce deferred tax assets to the amount that is expected more likely than not to be realized.

Significant components of the Company’s deferred tax assets as of December 31, 2015 and 2014 are listed below. A valuation allowance of $120.8 million and $124.9 million at December 31, 2015 and 2014, respectively, has been recognized to offset the net deferred tax assets as realization of such assets is uncertain.

Amounts for the years ended December 31 were as follows (in thousands):

Deferred Tax Assets	2015			2014
Net operating losses	$	83,143		$	85,510
Credit carryovers		19,903			19,903
Depreciation and amortization		13,944			14,922
Accruals and reserves		609			808
Capital loss carryover		85			100
Other		3,114			3,660
Total deferred tax assets		120,798			124,903
Less valuation allowance		(120,798	)		(124,903	)
Net deferred tax assets	$	—		$	—

In November 2015, the FASB issued Accounting Standard Update No. 2015-17, “Balance Sheet Classification of Deferred Taxes”, an update to ASC 740, Income Taxes (“Update”). Current GAAP requires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. To simplify the presentation of deferred income taxes, the amendments in this Update require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this Update.

For public business entities, the amendments in this update are effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Board also decided to permit earlier application by all entities as of the beginning of any interim or annual reporting period. The Board further provides that this Update may be applied to all deferred tax liabilities and assets retrospectively to all periods presented. The Company chose to adopt the Update in fiscal year ended December 31, 2015 and apply this Update on a prospective basis.

The reconciliation between the provision for income taxes and income taxes computed using the U.S. federal statutory corporate tax rate were as follows for the years ended December 31 (in thousands):

	2015			2014			2013
Computed “expected” tax benefit	$	(3,152	)	$	(5,607	)	$	(10,621	)
State income taxes, net of federal benefit		—			(444	)		(1,947	)
Tax effect of:
Change in valuation allowance		(4,069	)		5,102			13,074
Rate change		3,524			—			—
Expiration of prior year credits and net operating losses		786			675			(237	)
Research and development and other tax credits carryovers		—			—			(672	)
Stock compensation		376			274			337
Uncertain tax positions		3,074			—			—
Other		(539	)		—			66
Provision for income taxes	$	—		$	—		$	—

As of December 31, 2015 and 2014, the Company had available federal net operating loss carryforwards of approximately $311.3 million and $307.3 million, respectively, which expire from 2018 through 2035. In addition, the Company had federal research and development credit and orphan drug credit carryforwards of $26.3 million and $26.3 million as of December 31, 2015 and 2014, respectively, to reduce future federal income taxes, if any. These carryforwards expire from 2018 through 2033 and are subject to review and possible adjustment by the Internal Revenue Service. The Company also has available California state net operating loss carryforwards of approximately $262.8 million and $275.0 million as of December 31, 2015 and 2014, respectively, which expire from 2016 to 2035. In addition, the Company had California research and development credits of approximately $8.8 million as of December 31, 2015 and 2014 to reduce future California income tax, if any. The California research and development credits do not expire.

The Company generated windfall tax benefits from the settlement of certain stock awards. The tax benefit will be recorded as a credit to additional paid-in capital in the year the deduction reduces income taxes payable. The net operating loss carryforwards related to these windfall tax benefits of approximately $1.6 million are included in the net operating loss carryforwards disclosed above.

The Company recognizes liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that 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 that is more than 50% likely of being realized upon settlement. While the Company believes that it has appropriate support for the positions taken on its tax returns, the Company regularly assesses the potential outcome of examinations by tax authorities in determining the adequacy of its provision for income taxes.

The Company has not completed an analysis of uncertain tax positions related to credits recorded as deferred tax assets. If such analysis is performed at a later date and an uncertain tax position is identified, the related deferred tax asset would be reduced along with a corresponding reduction in the valuation allowance.

The following table summarizes the activity related to our unrecognized tax benefits (in thousands):

	2015		2014		2013
Beginning balance	$	582	$	—	$	—
Increases related to prior year tax positions		3,758		—		—
Increases related to current year tax positions		—		582		—
Ending balance	$	4,340	$	582	$	—

As of December 31, 2015 and 2014, the Company had gross unrecognized tax benefits of $4.3 million and $0.6 million, respectively, none of which would affect the effective tax rate. The Company does not anticipate any significant decreases in its unrecognized tax benefits over the next 12 months. The Company’s policy is to recognize the interest expense and/or penalties related to income tax matters as a component of income tax expense. The Company had no accrual for interest or penalties on its balance sheets at December 31, 2015 or December 31, 2014, and has not recognized interest and/or penalties in its statements of operations for any of the years ended December 31, 2015, 2014 or 2013.

The Company is subject to taxation in the United States and California. The Company’s tax years for 1997 and forward are subject to examination by the United States and California tax authorities due to the carryforward of unutilized net operating losses and R&D credits.