12. Income Taxes

The effective tax rate for the years ended December 31, 2016, 2015 and 2014 was zero percent. MLT was treated as a partnership for federal and state income tax purposes. Accordingly, no provision was made for income taxes for periods prior to the merger, since the Company’s net loss (subject to certain limitations) was passed through to the income tax returns of its members. Upon the incorporation of Gemphire on October 30, 2014, the Company became taxed as a corporation.

A reconciliation of income tax computed at the statutory federal income tax rate to the provision (benefit) for income taxes included in the accompanying statements of comprehensive loss is as follows:


	For the Year Ended December 31,
	2016		2015		2014
Income tax (benefit) provision at federal statutory rate	(34.0)	%	(34.0)	%	(34.0)	%
Valuation allowance	40.2		38.2		36.8
State income tax, net of federal benefit	(4.7)		(4.0)		(4.0)
Convertible notes	1.1		0.6		1.2
Research credits	(4.0)
Other	1.4		(0.8)		—
Effective tax rate	—	%	—	%	—	%

Significant components of the Company’s deferred tax assets and liabilities are summarized in the tables below as of (in thousands):


	Year Ended December 31,
Deferred tax assets:	2016		2015
Federal and state operating loss carryforwards	$	2,289	$	2,723
Research and development costs deferral election		5,254		—
Acquired intangibles		351		345
Accruals		13		—
Convertible notes		—		460
Charitable contributions		12		4
Stock-based compensation		633		41
Research and development credit carryforwards		768		95
		9,320		3,668
Valuation allowance		(9,320)		(3,657)
Total deferred tax assets, net of valuation allowance		—		11
Deferred tax liabilities:
Restricted stock awards		—		(11)
Total deferred tax liabilities		—		(11)
Net deferred tax assets	$	—	$	—

As of December 31, 2016 and 2015, the Company had gross deferred tax assets of approximately $9.3 million and $3.7 million, respectively. Realization of the deferred assets is primarily dependent upon future taxable income, if any, the amount and timing of which are uncertain. The Company has had significant pre‑tax losses since its inception. The Company has not yet generated revenues and faces significant challenges to becoming profitable. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance of $9.3 million and $3.7 million as of December 31, 2016 and 2015, respectively. U.S. net deferred tax assets will continue to require a valuation allowance until the Company can demonstrate their realizability through sustained profitability or another source of income.

As of December 31, 2016 and 2015, the tax effect of the Company’s federal net operating loss carryforwards was approximately $2.1 million and $2.4 million, respectively. The Company had federal research credit carryforwards as of December 31, 2016 and 2015 of approximately $0.7 million and $95,000, respectively. The federal net operating loss and tax credit carryforwards will begin to expire in 2034 if not utilized. As of December 31, 2016 and 2015, the Company had state net operating loss carryforwards with a tax effect of approximately $0.2 million and $0.3 million, respectively. The Company had state research credit carryforwards of $24,000 as of December 31, 2016 and no state research credit carryforwards as of December 31, 2015. The state net operating loss carryforwards will begin to expire in 2026, if not utilized, and the state research credit carryforwards will begin to expire in 2023 if not utilized.

Utilization of the net operating loss carryforwards and credits may be subject to a substantial annual limitation due to the ownership change limitations provided by Section 382 of the Internal Revenue Code of 1986, as amended, and similar state provisions. Generally, in addition to certain entity reorganizations, the limitation applies when one or more “5-percent shareholders” increase their ownership, in the aggregate, by more than 50 percentage points over a 36‑month time period testing period, or beginning the day after the most recent ownership change, if shorter. The annual limitation may result in the expiration of net operating losses and credits before utilization.

The Company recognizes interest and/or penalties related to uncertain tax positions in income tax expense. There were no uncertain tax positions as of December 31, 2016 and 2015, and as such, no interest or penalties were recorded to income tax expense.

The Company’s corporate returns are subject to examination for the 2014 and 2015 tax years for federal and subject to examination for the 2015 tax year in various state jurisdictions. Prior to this period, the Company filed partnership returns, resulting in its income being passed through to its members.