Note 21. Income Taxes

Income from continuing operations before taxes for the years ended December 31, 2012, 2011 and 2010 consists of the following:

	Year Ended December 31,

	2012			2011			2010
	(In thousands)
U.S. operations	$	(197,430	)	$	174,714		$	83,834
Foreign operations		(87,126	)		(98,330	)		(169,500	)

Income (loss) before income tax expense	$	(284,556	)	$	76,384		$	(85,666	)

For the years ended December 31, 2012, 2011 and 2010, the Company recorded an income tax benefit of $96.8 million, an income tax provision of $0.3 million and an income tax benefit of $0.8 million, respectively, related to income from continuing operations. The components of the provision (benefit) for income taxes were as follows:

	Year Ended December 31,

	2012			2011		2010
	(In thousands)
Current:
Federal	$	—		$	—	$	(767	)
State		55			74		(52	)
Foreign		19			65		—

Total current	$	74		$	139	$	(819	)

Deferred:
Federal	$	(93,555	)	$	—	$	—
State		(3,288	)		135		—
Foreign		—			—		—

Total deferred	$	(96,843	)	$	135	$	—

Total (benefit) provision for income taxes	$	(96,769	)	$	274	$	(819	)

The Company recorded an income tax benefit in 2012 of $96.8 million primarily related to a release of a portion of the valuation allowance in connection with the approval for Kyprolis. The Company's tax provision in 2011 of $0.3 million was primarily related to state minimum taxes and foreign income taxes. The Company's tax benefit in 2010 of $0.8 million was primarily related to its election to carryback net operating losses under the Worker, Homeownership and Business Association Act of 2009. The election enabled the Company to eliminate all federal Alternative Minimum Taxes (AMT) previously recorded in 2009.

Reconciliation between the Company's effective tax rate and the U.S. statutory tax rate for the years ended December 31, 2012, 2011 and 2010 is as follows:

	Year Ended December 31,

	2012			2011			2010
Federal income tax at statutory rate		35	%		35	%		35	%
State income tax, net of federal benefit		1	%		0	%		0	%
Foreign rate differential		(11	%)		45	%		(69	%)
Stock compensation expense		0	%		3	%		(3	%)
Research credits expense add-back		(2	%)		5	%		(8	%)
Non-deductible meals and entertainment expense		0	%		1	%		(1	%)
Contingent consideration		(7	%)		(36	%)		(32	%)
Other		(1	%)		0	%		1	%
Change in valuation allowance		19	%		(53	%)		78	%

Income tax expense		34.0	%		0.4	%		1	%

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of December 31, 2012 and 2011 are as follows:

	2012			2011

	(In thousands)
Deferred tax assets:
Net operating loss carryforwards	$	116,244		$	68,367
Tax credit carryforwards		111,463			92,408
Capitalized research and development		322			26
Accrued expenses		13,614			10,456
Stock options		10,698			13,786
Property and equipment		1,267			1,461
Intangible assets		47,130			52,168
Other long-term assets		3,521			4,125
Contingent consideration		8,338			9,029
Capitalized costs		8,116			9,101
Other		476			123

Total deferred tax assets		321,189			261,050
Valuation allowance		(197,503	)		(224,357	)

Total deferred tax assets after valuation allowance		123,686			36,693
Deferred tax liabilities:
Discount on debt offering		(20,998	)		(24,833	)
Intangible assets — in-process research and development		(151,212	)		(157,226	)

Total deferred tax liabilities		(172,210	)		(182,059	)

Net deferred tax assets (liabilities)	$	(48,524	)	$	(145,366	)

As part of accounting for the acquisition of Proteolix, the Company recorded goodwill and intangible assets. Amortization expenses associated with acquired intangible assets are generally not tax deductible. Intangible assets acquired for use in a particular research and development project are considered indefinite-lived intangible assets until the completion or abandonment of the associated research and development efforts.

In 2009, the Company had established a deferred tax liability of $157.1 million for the In-Process Research and Development costs ("IPR&D") as part of the business combination accounting for Proteolix, Inc. Because the IPR&D was considered to have an indefinite life, the deferred tax liability could not offset the Company's deferred tax assets. On July 20, 2012, the Company received approval for Kyprolis by the FDA in the U.S. Accordingly, management reassessed the IPR&D associated with the Proteolix, Inc. acquisition and started amortizing the U.S. portion of the Kyprolis IPR&D in the amount of $267.3 million. As a result of the approval and related change in assessment, the deferred tax liability related to the U.S. IPR&D can now be used to offset the Company's deferred tax assets. Accordingly, the Company recorded a non-cash income tax benefit in 2012 of $96.8 million to recognize the change in valuation allowance required by the change in assessment.

Realization of deferred tax assets is dependent upon future earnings, if any, the timing and the amount of which are uncertain. Accordingly, the net deferred tax assets, not including the deferred tax liability related to the non U.S. IPR&D, have been fully offset by a valuation allowance. The valuation allowance decreased $ 26.9 million in 2012, decreased by $26.3 million in 2011 and decreased by $7.8 million in 2010. The Company continues to maintain a full valuation allowance against its deferred tax assets because the Company does not believe it is more likely than not that they will be realized. On a quarterly basis, the Company reassesses its valuation allowance for deferred income taxes. The Company will consider reducing the valuation allowance when it becomes more likely than not the benefit of those assets will be realized.

At December 31, 2012, the Company had net operating loss carryforwards for federal and state income tax purposes of approximately $312.5 million and $437.6 million, respectively. These net operating losses may be available to reduce future taxable income, if any. Approximately $116.9 million of the federal and $40.3 million of the state net operating loss carryforwards represents the stock option deduction arising from activity under the Company's stock option plan, the benefit of which will increase additional paid in capital when realized. The federal net operating loss carryforwards expire beginning in 2026 through 2032, and the state net operating loss carryforwards begin to expire in 2016 through 2032 and may be subject to certain limitations. As of December 31, 2012, the Company has research and development credit and orphan drug credit carryforwards of approximately $100.2 million for federal income tax purposes that expire beginning in 2018 through 2032, and $11.0 million for California income tax purposes, which do not expire.

Utilization of the net operating loss and tax credit carryforwards may be subject to substantial annual limitations due to ownership change limitations provided by the Internal Revenue Code of 1986, as amended and similar state provisions. The annual limitations may result in the expiration of net operating loss and tax credit carryforwards before utilization.

The following table summarizes the activity related to our gross unrecognized tax benefit:

	Year Ended December 31,

	2012		2011		2010
	(In thousands)
Balance at January 1	$	11,860	$	11,860	$	-
Additions based on tax positions related to the current year		-		-		11,860
Additions/ Reductions for tax positions of prior years		-		-		-
Reductions for tax positions of prior years		-		-		-
Settlement		-		-		-

Balance at December 31	$	11,860	$	11,860	$	11,860

At December 31, 2012, all unrecognized tax benefits are subject to full valuation allowance and, if recognized, will not affect the annual effective tax rate.

The Company's policy for classifying interest and penalties associated with unrecognized income tax benefits is to include such items as tax expense. No interest or penalties have been recorded during the years ended December 31, 2012, 2011 and 2010.

The Company does not expect to have any significant changes to unrecognized tax benefits over the next twelve months other than potentially an adjustment resulting from our tax credit analysis mentioned above.

The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The tax years from 1993 and forward remain open to examination by federal and California authorities due to net operating loss and credit carryforwards. The Company is currently under examination by the California Franchise Tax Board. The Company is not under examination by the Internal Revenue Service or taxing authorities other than the California Franchise Tax Board.