Income Taxes

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was enacted and implements comprehensive tax legislation which, among other changes, reduces the federal statutory corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously deferred, creates new provisions related to foreign sourced earnings, eliminates the domestic manufacturing deduction and moves to a territorial system. Additionally, in December 2017, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which addresses how a company recognizes provisional amounts when a company does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the effect of the changes in the Tax Act. The Company has completed the accounting for all of the enactment-date income tax effects of the Act within the prescribed measurement period, as defined in SAB 118, which ended on December 22, 2018.

Based on the provisions of the Tax Act, the Company re-measured its U.S. deferred tax assets and liabilities and adjusted its deferred tax balances to reflect the lower U.S. corporate income tax rate at December 31, 2017. The Company recorded the impact of the rate change on the return to provision differences that resulted in an income tax benefit of $3.0 million which is included as a discrete item in the 2018 income tax benefit. The Company’s foreign subsidiaries do not have accumulated earnings that can be distributed; therefore, the provisions of the Act related to the repatriation of foreign earnings are not applicable to the Company at December 31, 2018.

The income tax (benefit) provision consisted of the following (in thousands):



	Current			Deferred			Total
Year ended December 31, 2018
Federal	$	2,768		$	(40,345	)	$	(37,577	)
State	(1,677		)	(2,093		)	(3,770		)
Foreign	32			5,042			5,074
	$	1,123		$	(37,396	)	$	(36,273	)
Year ended December 31, 2017
Federal	$	78,806		$	(105,006	)	$	(26,200	)
State	1,706			(9,785		)	(8,079		)
Foreign	89			(458		)	(369		)
	$	80,601		$	(115,249	)	$	(34,648	)
Year ended December 31, 2016
Federal	$	107,818		$	(26,377	)	$	81,441
State	11,247			(4,325		)	6,922
Foreign	—			(1,306		)	(1,306		)
	$	119,065		$	(32,008	)	$	87,057

The income tax provision differs from the “expected” tax expense computed by applying the U.S. Federal corporate income tax rates of 21% to income before income taxes, as follows (in thousands):



	Years Ended December 31,
	2018			2017			2016
Computed “expected” tax provision	$	(92,018	)	$	(20,719	)	$	94,955
Change in income taxes resulting from:
State income taxes, net of Federal income tax	(11,667		)	(537		)	4,501
Change in state income tax rate, net of Federal income tax	(16		)	(4,714		)	—
Foreign income tax (benefit) provision	(1,658		)	2,206			1,580
Deduction for domestic production activities	—			(2,527		)	(7,280		)
Stock compensation	2,480			(1,316		)	(11,395		)
R&D tax credits	(750		)	(1,200		)	(825		)
Nondeductible acquisition fees	(1,165		)	1,974			39
Interest and penalties from Federal audit	7,935			15,650			—
Federal rate change	(3,027		)	(26,902		)	—
Discrete adjustments to prior year	570			1,561			—
162(m) Officers Compensation Limitation	1,483			—			—
Other expense, net	934			1,201			2,564
Valuation allowance change	60,626			675			2,918
Income tax (benefit) provision	$	(36,273	)	$	(34,648	)	$	87,057

The geographic allocation of the Company’s income before income taxes between U.S. and foreign operations was as follows (in thousands):



	2018			2017			2016
Pre-tax (loss) income from U.S. operations	$	(428,299	)	$	(49,572	)	$	287,880
Pre-tax loss from foreign operations	(9,883		)	(9,626		)	(16,580		)
Total pre-tax (loss) income	$	(438,182	)	$	(59,198	)	$	271,300

Net deferred income taxes at December 31, 2018 and 2017 include (in thousands):



	December 31,
	2018			2017
Deferred tax assets:
Net operating loss carry-forward	$	48,766		$	25,100
Stock-based compensation	9,071			7,668
Chargeback reserves	14,173			17,802
Reserve for product returns	8,012			9,479
Inventory valuation reserve	9,688			10,207
Long-term debt	2,226			3,084
Interest greater than 30% of EBITDA	13,930			—
Other	16,444			10,806
Total deferred tax assets	$	122,310		$	84,146
Valuation allowance	(71,157		)	(10,531		)
Net deferred tax assets	$	51,153		$	73,615
Deferred tax liabilities:
Prepaid expenses	$	(2,137	)	$	(1,709	)
Depreciation & amortization – tax over book	(49,547		)	(108,788		)
Other	$	(35	)	$	—
Total deferred tax liabilities	$	(51,719	)	$	(110,497	)
Net deferred income tax (liability)	$	(566	)	$	(36,882	)

The Company records a valuation allowance to reduce net deferred income tax assets to the amount that is more likely than not to be realized. In performing its analysis of whether a valuation allowance to reduce the deferred income tax asset was necessary, the Company evaluated the data and believes that it is not more likely than not that the deferred tax assets in the US, India, and Switzerland will be realized. Accordingly, the company has recorded a full valuation allowance against US, India, and Switzerland deferred tax assets. The Company established a valuation allowance of $71.2 million, $10.5 million and $9.9 million against its deferred tax assets as of December 31, 2018, 2017 and 2016, respectively.

The deferred tax balances have been reflected gross on the balance sheet and are netted only if they are in the same jurisdiction.

The Company’s net operating loss (“NOL”) carry-forwards as of December 31, 2018 consist of four component pieces: (i) U.S. Federal NOL carry-forwards valued at $22.2 million, (ii) State NOL carry-forwards valued at $2.7 million (iii) foreign (Indian) NOLs of $23.7 million and (iv) foreign (Swiss) NOLs of $0.7 million. The U.S. Federal NOL carry-forwards were obtained through the Merck Acquisition completed in the fourth quarter of 2013 in addition to the current year loss generated. State NOL carry-forwards are primarily from the loss generated in current year. The Company has established a full valuation allowance against U.S. Federal and State NOL carry-forwards due to uncertainty related to future earnings projections. The Indian NOL carry-forwards of $23.7 million relate to operating losses by the Company’s subsidiary in India, which was acquired in 2012. The Company has established a valuation allowance against this entire amount. A portion of the Swiss NOL was obtained through the Akorn AG acquisition completed in the first quarter of 2015. It has also generated a loss in the current year. The NOL carry-forwards begin to expire in 2023 and, accordingly, the Company has established a valuation allowance against the entire amount.

The Company completed an examination of its Federal income tax return for the year ended December 31, 2015 by the Internal Revenue Service. The Company’s U.S. Federal income tax returns filed for years 2016 and 2017 are open for examination by the Internal Revenue Service. The majority of the Company’s state and local income tax returns filed for years 2015 through 2017 remain open for examination as well.

In accordance with ASC 740-10-25 - Income Taxes — Recognition, the Company performs reviews of its tax positions to determine whether it is “more likely than not” that its tax positions will be sustained upon examination, and if any tax positions are deemed to fall short of that standard, the Company reserves based on the financial exposure and the likelihood of its tax positions not being sustained. Based on its review as of December 31, 2018, the Company determined that it would not recognize tax benefits as follows (in thousands):



Balance at December 31, 2015	$	2,285
Additions relating to current year	303
Payments of amounts relating to prior years	(1,287		)
Balance at December 31, 2016	$	1,301
Additions relating to 2017	416
Additions relating to prior years	24,297
Terminations of exposures relating to prior years	(619		)
Balance at December 31, 2017	$	25,395
Additions relating to 2018	269
Additions relating to prior years	4,425
Terminations of exposures relating to prior years	(702		)
Balance at December 31, 2018	$	29,387

If recognized, $2.3 million of the above positions will impact the Company’s effective rate, while the remaining $27.1 million would result in adjustments to the Company’s deferred taxes. On December 31, 2018, the Company filed a non-automatic accounting method change related to the chargebacks and rebates reserves that accounts for $27.1 million of the unrecognized tax benefits. It is pending approval from the Internal Revenue Service as of December 31, 2018 and as such the Company reasonably expects this balance to reverse during the following year. Due to the uncertainty of both timing and resolution of potential income tax examinations, the Company is unable to determine whether the remaining December 31, 2018 balance of unrecognized tax benefits represent tax positions that could significantly change during the next twelve months. The Company accounts for interest and penalties as income tax expense. In the year ended December 31, 2018, the Company recorded a reduction to penalties of $0.4 million and increased the interest by $4.5 million. The Company recorded the current year interest, net of tax benefit, of $1.7 million related to unrecognized tax benefits. At December 31, 2018, the Company had accrued a total of $8.6 million and $12.1 million of penalties and interest, respectively.