11. Income Taxes

From inception through September 16, 2014, the Company was a Delaware LLC for federal and state income tax purposes, and therefore, all items of income or loss through September 16, 2014 flowed through to the members of the LLC. Effective September 16, 2014, the Company converted from an LLC to a C-corporation for federal and state income tax purposes. Prior to the conversion to a C-corporation, the Company did not record deferred tax assets or liabilities or have any net operating loss (NOL) carryforwards for federal income tax purposes. However, the Company had recorded a deferred tax asset for state income tax purposes, which consisted primarily of NOL carryforwards for state jurisdictions that did not recognize the Company’s LLC status.

Effective upon the conversion to a C-corporation, the Company became subject to income tax at the federal and state levels. Accordingly, as of December 31, 2016 and 2015 the Company recorded a deferred tax asset for federal and state income taxes.

As all of the Company’s income and loss is generated in the U.S., and attributable to the U.S. jurisdiction, there was no foreign income tax expense (benefit) for the years ended December 31, 2016, 2015 and 2014.

A reconciliation of income tax expense (benefit) computed at the statutory federal income tax rate of 34 percent to income tax expense (benefit) as reflected in the financial statements is as follows (in thousands):

	Years Ended December 31,
	2016			2015			2014
Federal income tax benefit at statutory rate	$	(21,556	)	$	(7,756	)	$	(1,089	)
State income tax benefit, net of federal benefit		(1,617	)		(1,511	)		(264	)
Change in income tax rates upon conversion to C-corporation		—			—			427
Federal deferred tax assets upon conversion to C-corporation		—			—			(105	)
Step-up in assets upon conversion to C-corporation		—			(709	)		(448	)
Research and development credits		(7,275	)		—			—
Stock-based compensation expense for incentive stock options and employee stock purchase plan		1,805			283			98
Other non-deductible expenses and reconciling items		212			240			129
Change in valuation allowance		27,996			9,453			1,252
Total income tax expense (benefit)	$	(435	)	$	—		$	—

The significant components of the Company’s net deferred tax assets are as follows (in thousands):

	December 31, 2016			December 31, 2015
Deferred tax assets:
Net operating loss carryforwards	$	25,625		$	9,254
Research and development tax credits		10,890			—
Step-up in assets upon conversion to C-corporation		953			1,046
Stock-based compensation expense for non-qualified stock options and restricted stock units		1,401			855
Unrealized losses on marketable securities		—			284
Deferred rent		258			97
Accruals and other		1,132			568
Total deferred tax assets before valuation allowance		40,259			12,104
Valuation allowance		(40,084	)		(12,093	)
Total deferred tax assets		175			11
Deferred tax liabilities:
Depreciation		(19	)		(11	)
Unrealized gains on marketable securities		(156	)		—
Total deferred tax liabilities		(175	)		(11	)
Net deferred tax assets	$	—		$	—

The Company has evaluated the positive and negative evidence bearing upon the realizability of its deferred tax assets. Based on the Company’s history of operating losses, the Company has concluded that it is more likely than not that the benefit of its deferred tax assets will not be realized. Accordingly, the Company has provided a full valuation allowance for its net deferred tax assets as of December 31, 2016 and 2015. The valuation allowance increased approximately $28.0 million and $9.5 million during the years ended December 31, 2016 and 2015, respectively, due primarily to federal net operating losses and research and development credits generated during the periods. The net increase in the valuation allowance during the year ended December 31, 2016 includes a partially offsetting decrease of $0.4 million for the income tax effects of gains on available-for-sale securities recognized in other comprehensive income for the period.

As of December 31, 2016 and 2015, the Company had U.S. federal NOL carryforwards of approximately $66.4 million and $21.2 million, respectively, which may be available to offset future income tax liabilities and expire at various dates beginning in 2034. As of December 31, 2016 and 2015, the Company also had U.S. state NOL carryforwards of approximately $55.0 million and $34.2 million, respectively, which may be available to offset future income tax liabilities and expire at various dates beginning in 2035.

As of December 31, 2016, the Company had federal research and development and orphan drug tax credit carryforwards of approximately $11.0 million which may be available to reduce future tax liabilities and expire at various dates beginning in 2035. The Company has conducted a formal study to document the qualified activities and expenses used to calculate the credits through the year ended December 31, 2015. The remaining portion of the credits as of December 31, 2016 are subject to future studies which may result in an adjustment to the Company’s credit carryforwards. The calculation of these credits require assumptions to be made by management to estimate qualified research expenses. The Company accounts for uncertain tax positions in accordance with the provisions of ASC 740, and accordingly, recognizes the tax benefit of tax positions to the extent that the benefit will more likely than not be realized. As of December 31, 2016, the Company has unrecognized tax benefits of $0.1 million which have been reserved against the credit carryforwards as uncertain tax positions. No reserve for uncertain tax positions has been placed against qualified expenses for which a study has not been conducted. However, a full valuation allowance has been provided against the net credit carryforwards and, if an adjustment is required upon the completion of the study, this adjustment would be offset by an adjustment to the deferred tax asset established for the research and development credit carryforwards and the valuation allowance.

Under the provisions of the Internal Revenue Code, the NOL and tax credit carryforwards are subject to review and possible adjustment by the Internal Revenue Service and state tax authorities. NOL and tax credit carryforwards may become subject to an annual limitation in the event of certain cumulative changes in the ownership interest of significant shareholders over a three-year period in excess of 50 percent, as defined under Sections 382 and 383 of the Internal Revenue Code, respectively, as well as similar state provisions. This could limit the amount of tax attributes that can be utilized annually to offset future taxable income or tax liabilities. The amount of the annual limitation is determined based on the value of the Company immediately prior to the ownership change. Subsequent ownership changes may further affect the limitation in future years. The Company has completed several financings since its inception which may have resulted in a change in control as defined by Sections 382 and 383 of the Internal Revenue Code, or could result in a change in control in the future.

The Company files income tax returns in the U.S. at the federal level and in states in which the Company conducts business activities. The federal and state income tax returns are generally subject to tax examinations for the tax years ended December 31, 2013 through December 31, 2016. To the extent the Company has tax attribute carryforwards, the tax years in which the attribute was generated may still be adjusted upon examination by the Internal Revenue Service or state tax authorities to the extent utilized in a future period.