8. INCOME TAXES

The provision for income taxes consists of the following:

Year ended December 31,

		2012		2011			2010
Current taxes:
Federal	$	686,968	$	-		$	-
State		12,182		3,525			1,351
Total current taxes		699,150		3,525			1,351
Deferred taxes:
Federal		1,134,532		(1,219,190	)		-
State		340,372		(122,593	)		-
Total deferred taxes		1,474,904		(1,341,783	)		-
Total provision for income taxes	$	2,174,054	$	(1,338,258	)	$	1,351

The effective income tax rate of the Company differs from the federal statutory tax rate of 34% due to the following items:

Year ended December 31,

	2012			2011			2010
Statutory rate		34.00	%		34.0	%		34.0	%
State income taxes, net of federal income tax benefit		0.16	%		7.1	%		5.0	%
Stock-based compensation		1.51	%		4.0	%		(42.8	)%
Change in effective state tax rate		6.59	%		-			-
Other, net		(0.08	)%		(5.9	)%		21.4	%
Increase (decrease) in valuation allowance		-			(64.6	)%		(17.6	)%
Effective tax rate (benefit)		42.18	%		(25.4	%)		-

The effective rate reconciliation includes the permanent differences and changes in valuation allowance for windfalls, stock-based compensation, and net operating loss.

Deferred income taxes reflect the 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. The components of deferred income tax assets and liabilities are as follows:

Year ended December 31,

	2012		2011		2010

Tax credit carry forward	$	-	$	1,027,633	$	1,027,633
Deferred revenues		132,514		293,297		466,981
Other		27,322		17,253		-
Options		1,413,214		1,687,780		1,757,303
Net operating loss carry forward		-		21,992		350,617
Net deferred tax assets before valuation allowance		1,573,050		3,047,955		3,602,534
Valuation allowance		-		-		(3,602,534	)
Net deferred tax asset	$	1,573,050	$	3,047,955	$	-

Company considers all available information, including operating results, ongoing tax planning, and forecasts of future taxable income. Our valuation allowance as of December 31, 2010 related primarily to Federal Orphan Drug Tax Credit and net operating loss carryforwards. Based on the results of our operations in 2010 and 2011, the growth in the market for XIAFLEX, and the trend in actual and anticipated royalty income, we had determined that it was more likely than not that the benefit of our deferred tax assets would be realized. Consequently, in 2011, we eliminated the valuation allowance of $3.6 million.

Stock-based compensation, recorded in the Company's financial statements is non-deductible for tax purposes and increases the Company's effective tax rate. Deferred tax assets, including those associated with stock based compensation, are reviewed and adjusted for apportionment and potential tax rates changes in various jurisdictions. In 2012, our tax assets related to stock-based compensation decreased by $0.3 million, due to a reduction in our estimated state tax apportionment rate.

Federal and state net operating losses from the exercise of employee stock options are not recorded on the Company's consolidated statements. Federal and state net operating loss carryforwards that result from the exercise of employee stock options are accounted for as a credit to tax assets from stock based compensation and additional paid-in capital if and when realized through a reduction in income taxes payable. We recognized $0.8 million, $0.7 million and $2.0 million of tax deductible expenses from the exercise of non-qualified or a disqualified disposition of incentive stock options, in 2012, 2011 and 2010 respectively.

In 2012, we used $1.0 million of our Orphan Drug tax credit to reduce our federal income tax payable. We recognized the tax effect of $0.8 million related to the exercise of nonqualified options in our financial statements, which lowered our taxes payable by $0.3 million, reduced our tax assets related to non-qualified stock options by $32,000 and increased additional paid in capital by $0.3 million. Additionally, we utilized tax assets from our federal and state net operating loss carryforwards of $16,000 and deferred licensing revenue of $0.1 million to reduce our taxes payable. Because our state net operating losses of $4.2 million exceeded our federal net operating losses of $47,000 we set up a valuation allowance of $0.3 million against our tax asset of our state net operating loss carryforwards.

As of December 31, 2012, the Company believes that there are no significant uncertain tax positions, and no amounts have been recorded for interest and penalties. The Company expect any events that it would be required to record a liability related to an uncertain tax position.