Note 13 — Income Taxes

Loss before provision for income taxes includes the following components (in thousands):


	Year Ended December 31,
	2012			2011			2010
Domestic	$	(174,258	)	$	(135,880	)	$	(39,321	)
Foreign		2,809			2,920			2,264

Loss before provision for income taxes	$	(171,449	)	$	(132,960	)	$	(37,057	)

Provision for Income Taxes

The provision (benefit) for income taxes consists of the following (in thousands):


	Year Ended December 31,
	2012			2011		2010
Current:
Federal	$	(137	)	$	—	$	1
State		1			1		2
Foreign		1,029			921		698

Total Current		893			922		701

Deferred:
Federal		(422	)		—		—
State		(49	)		—		—
Foreign		(16	)		96		180

Total Deferred		(487	)		96		180

Provision for income taxes	$	406		$	1,018	$	881

Income tax provision related to continuing operations differs from the amount computed by applying the statutory income tax rate of 35% to pretax loss as follows (in thousands):


	Year Ended December 31,
	2012			2011			2010
U.S. federal provision (benefit)
At statutory rate	$	(60,007	)	$	(46,536	)	$	(12,970	)
State taxes		(48	)		1			2
Change in valuation allowance		47,349			48,959			15,123
Foreign tax inclusion		6,510			—			—
Non-cash interest expense on liability related to sale of future royalties		6,320			—			—
Foreign tax differential		(227	)		(129	)		86
Unrecognized tax credits		(591	)		(893	)		(1,833	)
Other		1,100			(384	)		473

Provision for income taxes	$	406		$	1,018		$	881

Deferred Tax Assets and Liabilities

Deferred income taxes reflect the net tax effects of loss and credit carryforwards and temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax assets for federal and state income taxes are as follows (in thousands):


	December 31,
	2012			2011
Deferred tax assets:
Net operating loss carryforwards	$	351,354		$	342,128
Research and other credits		52,769			51,125
Sale of future royalties		39,750			—
Deferred revenue		39,521			48,732
Stock-based compensation		23,746			19,268
Capitalized research expenses		7,192			9,514
Property and equipment		8,482			8,081
Reserves and accruals		8,776			8,083
Other		2,773			3,895

Deferred tax assets before valuation allowance		534,363			490,826
Valuation allowance for deferred tax assets		(534,268	)		(490,689	)

Total deferred tax assets		95			137

Deferred tax liabilities:
Property and equipment		—			(75	)

Total deferred tax liabilities		—			(75	)

Net deferred tax assets	$	95		$	62

Realization of our deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Because of our lack of U.S. earnings history, the net U.S. deferred tax assets have been fully offset by a valuation allowance. The valuation allowance increased by $43.6 million and $52.9 million during the years ended December 31, 2012 and 2011, respectively. The valuation allowance includes approximately $35.6 million of income tax benefit at both December 31, 2012 and December 31, 2011 related to stock-based compensation and exercises prior to the implementation of the accounting guidance for stock-based compensation that will be credited to additional paid in capital when realized.

Undistributed earnings of our foreign subsidiary in India are considered to be permanently reinvested and accordingly, no deferred U.S. income taxes have been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, we would be subject to U.S. income tax. As of December 31, 2012, U.S. income taxes have not been provided on a cumulative total of $3.1 million of such earnings. At the present time it is not practicable to estimate the amount of U.S. income taxes that might be payable if these earnings were repatriated.

Net Operating Loss and Tax Credit Carryforwards

As of December 31, 2012, we had a net operating loss carryforward for federal income tax purposes of approximately $909.4 million, portions of which will begin to expire in 2018. We had a total state net operating loss carryforward of approximately $602.5 million, which will begin to expire in 2013. Utilization of some of the federal and state net operating loss and credit carryforwards are subject to annual limitations due to the “change in ownership” provisions of the Internal Revenue Code of 1986 and similar state provisions. The annual limitations may result in the expiration of net operating losses and credits before utilization.

We have federal research credits of approximately $23.7 million, which will begin to expire in 2019 and state research credits of approximately $14.7 million which have no expiration date. We have federal orphan drug credits of $14.0 million which will begin to expire in 2026. These tax credits are subject to the same limitations discussed above.

The American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013. The act retroactively reinstated various expired tax extenders for the 2012 year. None of the extenders included in the Act are material to our financial statements and the impact of the tax law change will be accounted for in 2013 as this is the period of enactment.

A change in California law occurred in November 2012 with the enactment of RTC Sec. 25128.7 related to apportionment of income. The new law is effective beginning in 2013. All California deferred tax assets have been adjusted using the rates that will be in effect when the deferred tax assets are expected to be utilized.

Unrecognized tax benefits

We have incurred net operating losses since inception. Our policy is to include interest and penalties related to unrecognized tax benefits, if any, within the provision for income taxes in the consolidated statements of operations. If we are eventually able to recognize our uncertain positions, our effective tax rate would be reduced. We currently have a full valuation allowance against our net deferred tax asset which would impact the timing of the effective tax rate benefit should any of these uncertain tax positions be favorably settled in the future. Any adjustments to our uncertain tax positions would result in an adjustment of our net operating loss or tax credit carry forwards rather than resulting in a cash outlay.

We file income tax returns in the U.S., California, Alabama, India and the U.K. The 2009 and 2010 tax years were previously under audit by the IRS. These audits were completed and we received no change letters. The 2005 through 2010 tax years were previously under audit in Alabama. These audits were completed with no changes to the tax liability. Because of net operating losses and research credit carryovers, substantially all of our domestic tax years remain open and subject to examination. We are currently under examination in India for the fiscal years ending 2009 through 2011.

We have the following activity relating to unrecognized tax benefits (in thousands):


	December 31,
	2012			2011		2010
Beginning balance	$	13,576		$	13,058	$	13,084
Tax positions related to current year
Additions:
Federal		289			297		259
State		302			221		208
Reductions		—			—		—
Tax positions related to prior year
Additions:
Federal		37			—		—
State		—			—		—
Reductions		—			—		(493	)
Settlements		—			—		—
Lapses in statute of limitations		(137	)		—		—

Ending balance	$	14,067		$	13,576	$	13,058

Although it is reasonably possible that certain unrecognized tax benefits may increase or decrease within the next twelve months due to tax examination changes, settlement activities, expirations of statute of limitations, or the impact on recognition and measurement considerations related to the results of published tax cases or other similar activities, we do not anticipate any significant changes to unrecognized tax benefits over the next twelve months. During the years ended December 31, 2012, 2011 and 2010, no interest or penalties were required to be recognized relating to unrecognized tax benefits.