8. INCOME TAXES

The provision for income taxes consists of the following:

Year ended December 31,

	2011			2010		2009
Current taxes:
Federal	$	-		$	-	$	(198,239	)
State		3,525			1,351		1,784
Total current taxes		3,525			1,351		(196,455	)
Deferred taxes:
Federal		(122,593	)		-		-
State		(1,219,190	)		-		-
Total deferred taxes		(1,341,783	)
Total provision for income taxes	$	(1,338,258	)	$	1,351	$	(196,455	)

The effective income tax rate of the Company differs from the federal statutory tax rate of 34% due to the following items:

Year ended December 31,

	2011			2010			2009
Statutory rate		34.0	%		34.0	%		34.0	%
State income taxes, net of federal income tax benefit		7.1	%		5.0	%		5.0	%
Stock-based compensation		4.0	%		(42.8	%)		(23.9	%)
Other, net		(5.9	%)		21.4	%		10.7	%
Increase (decrease) in valuation allowance		(64.6	%)		(17.6	%)		(25.8	%)
Effective tax rate (benefit)		(25.4	%)		-			3.2	%

The effective rate reconciliation includes the permanent differences and changes in valuation allowance for windfalls, stock-based compensation, and net operating loss.

Year ended December 31,

	2011		2010			2009

Tax credit carry forward	$	1,027,633	$	1,027,633		$	1,039,390
Deferred revenues		293,297		466,981			741,714
Other		17,252		-			54,846
Options		1,687,780		1,757,303			406,517
Net operating loss carry forward		21,992		350,617			556,504
Net deferred tax assets before valuation allowance		3,047,955		3,602,534			2,798,971
Valuation allowance		-		(3,602,534	)		(2,798,971	)
Net deferred tax asset	$	3,047,955	$	-		$	-

In assessing the realization of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the temporary differences representing net future deductible amounts become deductible. Based on our current and anticipated future taxable income, we have released the valuation allowance for all or our deferred tax assets.

At December 31, 2010, we had a full valuation allowance of $3.6 million against our tax assets. In 2011, 2010 and 2009, we had $0.7 million, $2.0 million and $1.9 million of unutilized tax deductible expenses from the exercise of non-qualified and disqualified disposition of incentive stock options, respectively. Based on the results of our operations over the last two years, the growth in the market for XIAFLEX, and the trend in actual and anticipated royalty income, we have determined that is was more likely than not that the benefit of our deferred tax assets will be realized. Consequently, we have eliminated the valuation allowance of $3.6 million and increased our deferred tax assets by $0.3 million to reflect the application of our state statutory rates of 7.1% to temporary differences.

Under the ASC 718-25-09, we recognized the tax effect of $4.6 million in disqualifying disposition of options and the exercise of nonqualified options in our financial statements for the year ended December 31, 2011. The exercise of nonqualified options and disposition of disqualified options lowered our taxes payable by $1.9 million, reduced our tax assets related to non-qualified options by $0.2 million and increased additional paid in capital and provision for income tax benefits by $1.7 million and $30,239, respectively. Additionally, we utilized tax assets from our federal and state net operating loss carryforwards of $0.3 million and deferred licensing revenue of $0.2 million to reduce our taxes payable. Because our state net operating losses exceeded our federal net operating losses we set up a valuation allowance of $0.2 million against our tax asset for our state net operating loss carryforwards.

In the 2010 period we had a tax expense of $1,351. The income tax expense for 2010 was the result of minimum New York State taxes.

As of December 31, 2011, the Company believes that there are no significant uncertain tax positions, and no amounts have been recorded for interest and penalties. The Company does not anticipate any events that would require it to record a liability related to any uncertain tax position.