Income Taxes

The Company has incurred cumulative net operating losses ("NOLs") since inception and, consequently, has not recorded any income tax expense for the years ended December 31, 2019 and 2018 due to its net operating loss position.

The reconciliation of the federal statutory income tax rate to the Company’s effective tax rate is as follows:



	Year Ended December 31, 2019		Year Ended December 31, 2018
Federal statutory tax rate	(21.0	)%	(21.0	)%
State statutory tax rate, net of federal benefit	(7.0	)	(7.0	)
Research and development credits, net of uncertain tax positions	(2.6	)	(2.6	)
Derecognition due to Section 382 and 383	0.9		25.4
Stock-based compensation	0.7		0.5
Permanent items	—		5.6
Change in valuation allowance	29.0		(0.9	)
Total	—	%	—	%

The research and development credits, net of uncertain tax positions percentage disclosed for the year ended December 31, 2018 was previously reported in the 2018 notes to financial statements as a component of permanent items. The reclassification had no impact on our financial statements for the year ended December 31, 2018.

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. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the deferred tax assets have been fully offset by a valuation allowance. The net valuation allowance increased by approximately $10.9 million and decreased by $0.3 million during the years ended December 31, 2019 and 2018, respectively.

Significant components of the Company’s net deferred tax assets and liabilities are as follows:



	Year Ended December 31, 2019			Year Ended December 31, 2018
	(in thousands)
Net operating loss carryforwards	$	20,717		$	10,942
Research and development credits	4,809			3,657
Depreciation and amortization	638			729
Accruals	558			569
Deferred rent	—			400
Lease liability	1,980			—
Stock-based compensation	331			213
Capital loss carryforwards	23			23
Other	8			2
Total gross deferred tax assets	29,064			16,535
Valuation allowance	(27,450		)	(16,535		)
	1,614			—
Right-of-use assets	(1,614		)	—
Net deferred tax assets	$	—		$	—

As of December 31, 2019, the Company had federal net operating loss carryforwards of approximately $76.0 million and state net operating loss carryforwards of approximately $68.2 million. As of December 31, 2018, the Company had federal net operating loss carryforwards of approximately $41.1 million and state net operating loss carryforwards of approximately $33.2 million. If not utilized, certain federal net operating loss carryforwards incurred before January 1, 2018, will expire beginning in 2026, and state net operating loss carryforwards will expire beginning in 2028. The federal net operating losses incurred in 2018 and beyond do not expire.

If the Company experiences a greater than 50 percentage point aggregate change in ownership over a 3-year period (a Section 382 ownership change), utilization of its pre-change NOL carryforwards are subject to annual limitation under Section 382 of the Internal Revenue Code (California has similar provisions). The annual limitation is determined by multiplying the value of the Company’s stock at the time of such ownership change by the applicable long-term tax-exempt rate. Such limitations may result in expiration of a portion of the NOL carryforwards before utilization. As of December 31, 2019, the Company determined that ownership changes occurred on February 26, 2014, November 30, 2015, March 22, 2017 and April 3, 2018. As a result of the ownership changes, approximately $221.7 million and $197.5 million of the NOLs will expire unutilized for federal and California purposes, respectively. As of December 31, 2019, the Company has derecognized NOL related deferred tax assets in the tax affected amounts of $46.6 million and $13.8 million for federal and California purposes, respectively. The ability of the Company to use its remaining NOL carryforwards may be further limited if the Company experiences a Section 382 ownership change as a result of future changes in its stock ownership.

In February 2018, the SEC staff issued SAB 118 which provided guidance on accounting for the tax effects of the Tax Reform Act. SAB 118 provided a measurement period should not extend beyond one year from the Tax Reform Act enactment date for companies to complete the accounting related to the Tax Reform Act under ASC 740, Income Taxes. The Company completed its assessment of the accounting impact resulting from the Tax Reform Act in the fourth quarter of 2018 and determined there was no adjustment to the Company’s financial statements.

As of December 31, 2019, the Company had federal and state research and development credit carryforwards of approximately $1.6 million and $5.6 million, respectively. As of December 31, 2018, the Company had federal and state research and development credit carryforwards of approximately $0.6 million and $5.1 million, respectively. If not utilized, the federal tax credits will begin to expire in 2038 and state tax credits currently do not expire. Research and development credits are subject to IRC section 383. In the event of a change in ownership as defined by this code section, the usage of the credits may be limited. As a result of the previously mentioned ownership changes, the Company has derecognized approximately $5.1 million of gross federal research and development credit-related deferred tax assets due to the Section 383 limitation as of December 31, 2019. The Company has not derecognized any of the California research and development credit-related deferred tax assets because the credits do not expire.

Uncertain Income Tax Positions

The Company only recognizes tax benefits if it is more likely than not that they will be sustained upon audit by the relevant tax authority based upon their technical merits. An uncertain tax position is not recognized if it has less than a 50% likelihood of being sustained.

The Company had approximately $1.4 million of unrecognized tax benefits as of December 31, 2019 and approximately $1.1 million of unrecognized tax benefits as of December 31, 2018. As the Company has a full valuation allowance on its deferred tax assets, the unrecognized tax benefits reduce the deferred tax assets and the valuation allowance in the same amount. The Company does not expect the amount of unrecognized tax benefits to materially change in the next twelve months. A reconciliation of the beginning and ending balance of the unrecognized tax benefits is as follows:



	Year Ended December 31, 2019		Year Ended December 31, 2018
	(in thousands)
Balance at the beginning of year	$	1,128	$	1,006
Increase (decrease) related to prior year tax positions	47		(77		)
Increase related to current year tax positions	264		199
Balance at the end of year	$	1,439	$	1,128

As of December 31, 2019 and 2018, the Company had not recognized any tax-related interest or penalties in its financial statements. Any interest and penalties related to unrecognized tax benefits would be included as income tax expense in the Company’s statements of operations.

The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is not currently under audit by the Internal Revenue Service or any other similar state, local, or foreign authority. All tax years remain open to examination by major taxing jurisdictions to which the Company is subject.