aTYR PHARMA INC Income Taxes Disclosure

8. Income Tax

Pretax losses were generated by both domestic and foreign operations as follows (in thousands):

 

 

For the years ended December 31, 2020, 2019, and 2018, we did not record a provision for income taxes due to a full valuation allowance against our deferred taxes. A reconciliation of the expected statutory federal income tax provision to the actual income tax provision is summarized as follows (in thousands):

 

 

Deferred income taxes are provided for temporary differences in recognizing certain income and expense items for financial and tax reporting purposes. The deferred tax assets consisted primarily of the income tax benefits from net operating loss (NOL) carryforwards, research and development credits and capitalized research and development expenses, along with other accruals and reserves. Valuation allowances of $74.6 million and $71.7 million as of December 31, 2020 and 2019, respectively, have been recorded to offset deferred tax assets as realization of such assets does not meet the more-likely-than-not threshold under ASC 740, Accounting for Income Taxes.

Significant components of our deferred tax assets are summarized as follows (in thousands):

 

 

As of December 31, 2020, we had federal NOL carryforwards of approximately $177.8 million, with $65.3 million of NOLs generated after December 31, 2017 carrying forward indefinitely and $112.5 million of NOLs that will begin to expire in 2025. NOLs generated after January 1, 2018 are subject to an 80% of taxable income limitation when utilized after December 31, 2020 in accordance with the Tax Cuts and Jobs Act of 2017 as modified by the Coronavirus Aid, Relief and Economic Security Act (CARES Act). We had state net operating loss carryforwards of approximately $164.1 million, and foreign net operating loss carryforwards of $8.3 million. The state net operating losses will begin to expire in 2021. The foreign net operating losses carry over indefinitely.

 

As of December 31, 2020, we had federal and state research and development credit carryforwards of approximately $5.5 million and $4.5 million, respectively, which begin to expire in 2026 for federal purposes and carry over indefinitely for state purposes. We had $12.5 million of federal Orphan Drug Credits as of December 31, 2020, which will begin to expire in 2035.

Utilization of the domestic NOL and research and development credit carryforwards may be subject to a substantial annual limitation due to ownership change limitations that may have occurred or that could occur in the future, as required by Sections 382 and 383 of the Internal Revenue Code of 1986, as amended (the Code), as well as similar state and foreign provisions. These ownership changes may limit the amount of NOL and research and development credit carryforwards that can be utilized annually to offset future taxable income and tax, respectively. In general, an “ownership change” as defined by Section 382 of the Code results from a transaction or series of transactions over a three-year period resulting in an ownership change of more than 50 percentage points of the outstanding stock of a company by certain stockholders. Since the Company’s formation, we raised capital through the issuance of capital stock on several occasions which on its own or combined with the purchasing stockholders’ subsequent disposition of those shares, has resulted in such an ownership change, and could result in an ownership change in the future.

 

Upon the occurrence of an ownership change under Section 382 as outlined above, utilization of the NOL and research and development credit carryforwards become subject to an annual limitation under Section 382 of the Code, which is determined by first multiplying the value of our stock at the time of the ownership change by the applicable long-term, tax-exempt rate, which could be subject to additional adjustments. Any limitation may result in expiration of a portion of our NOL or research and development credit carryforwards before utilization. Due to the existence of the valuation allowance, any impact to the NOL and research and development tax credit carryforwards from Section 382 analysis will be offset by a corresponding adjustment to valuation allowance, resulting in no tax provision impact.

We recognize a tax benefit from an uncertain tax position when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized.

Our practice is to recognize interest and penalties related to income tax matters in income tax expense. We had no accrual for interest and penalties on our balance sheet and had not recognized interest or penalties in the consolidated statements of operations for the years ended December 31, 2020, 2019 and 2018.

Due to the existence of the valuation allowance, future changes in unrecognized tax benefits will not impact our effective tax rate.

Uncertain tax positions are evaluated based upon the facts and circumstances that exist at each reporting period. Subsequent changes in judgment based upon new information may lead to changes in recognition, derecognition, and measurement. Adjustments may result, for example, upon resolution of an issue with the taxing authorities, or expiration of a statute of limitations barring an assessment for an issue.

The activity related to our unrecognized tax benefits is summarized as follows (in thousands):

 

 

We do not anticipate that the amount of unrecognized tax benefits as of December 31, 2020 will change within the next twelve months.

 

We are subject to taxation in the United States, Hong Kong and state jurisdictions. Our tax years from inception are subject to examination by the United States, Hong Kong and California authorities due to carry forward of unutilized NOLs and research and development credits. 

On March 27, 2020, the CARES Act was enacted and signed into law in response to COVID-19. The CARES Act, among other things, included several significant provisions that impacted corporate taxpayers’ accounting for income taxes. Prior to the enactment of the CARES Act, the 2017 Tax Cuts and Jobs Act generally eliminated the ability to carryback net operating losses (NOLs), and permitted the NOLs arising in tax years beginning after December 31, 2017 to be carried forward indefinitely, limited to 80% of the taxpayer’s income. The CARES Act amended the NOL rules, suspending the 80% limitation on the utilization of NOLs generated after December 31, 2017 and before January 1, 2021. Additionally, the CARES Act allows corporate NOLs arising in taxable years beginning after December 31, 2017 and before January 1, 2021, to be carried back to each of the five taxable years preceding the taxable year of the loss. Also, the CARES Act allows companies to defer making certain payroll tax payments until future years. With the enactment of the CARES Act, we do not expect a material impact on our consolidated financial positions or results of operations.

On December 27, 2020, the United States enacted the Consolidated Appropriations Act of 2021 (CAA). The CAA includes provisions extending certain CARES Act provisions and adds coronavirus relief, tax and health extenders. We will continue to evaluate the impact of the CAA and its impact on our consolidated financial positions or results of operations in 2021 and future years.

In June 29, 2020, the state of California passed Assembly Bill 85 (AB 85) which suspends the California net operating loss deduction during tax years 2020 through 2022.  AB 85 also applies limitation to the amount of tax that can be offset by business credits to $5.0 million for tax years 2020 through 2022. These suspensions were considered in preparation of our 2020 consolidated financial positions or results of operations.