10. INCOME TAXES

        For the years ended December 31, 2012, 2011 and 2010, our income (loss) before income taxes was from domestic operations. For the year ended December 31, 2012 and 2011, we did not record a provision for income taxes due to our net loss. For the year ended December 31, 2010, we did not record a provision for income taxes because of the utilization of net operating loss carryforwards for federal tax purposes and manufacturing investment credits for state tax purposes.

        Deferred income taxes reflect the net 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. Significant components of our deferred tax assets are as follows (in thousands):

        The reconciliation of the statutory federal income tax rate to the effective tax rate was as follows:

        In general, under Section 382 of the Internal Revenue Code ("Section 382"), a corporation that undergoes an ownership change is subject to limitations on its ability to utilize its pre-change net operating loss carryovers and tax credits to offset future taxable income. Our existing net operating loss carryforwards and tax credits are subject to limitations arising from ownership changes which occurred in previous periods. We finalized our analysis of potential ownership changes and concluded our Section 382 owner shift analysis during the year ended December 31, 2012. We have updated our net operating loss carryforwards to reflect the results of the Section 382 owner shift analysis as of December 31, 2012. Future changes in our stock ownership, some of which are outside of our control, could result in an ownership change under Section 382 and result in additional limitations.

        As of December 31, 2012, we had net operating loss carryforwards for federal income tax purposes of approximately $563.2 million, which expire beginning in the year 2019 and state net operating loss carryforwards of approximately $307.9 million, which expire beginning in the year 2014.

        We also have federal research and development tax credits of approximately $14.3 million, which begin to expire in the year 2023 and state research and development tax credits of approximately $18.3 million, which have no expiration date.

        The American Taxpayer Relief Act of 2012, which extended the federal research and development credit for 2012, was not enacted until January 2, 2013. As such, no federal research and development tax credits were recorded related to 2012 for the year ended December 31, 2012. We expect to recognize the impact of federal research and development tax credits generated in 2012 of $2.6 million in a future period.

        Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance increased by approximately $51.7 million and $34.5 million for the years ended December 31, 2012 and 2011, respectively.

        Included in the valuation allowance balance at December 31, 2012 and 2011 is approximately $2.5 million of tax deductions related to the exercise of stock options prior to the adoption of ASC 718 which have not reflected as an expense for financial reporting purposes. Accordingly, any future reduction in the valuation allowance relating to this amount will be credited directly to equity and not reflected as an income tax benefit in the statement of operations. As a result of certain realization requirements, the table of deferred tax assets and liabilities shown above does not include loss carryforward tax assets of approximately $1.7 million at December 31, 2012 and 2011 that arose directly from (or the use of which was postponed by) tax deductions related to stock-based compensation expense in excess of compensation expense recognized for financial reporting. Equity will be increased by approximately $1.7 million if and when such deferred tax assets are ultimately realized.

        Utilization of our net operating losses may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration of the net operating losses before utilization.

        The following table summarizes the activity related to our gross unrecognized tax benefits (in thousands):

        Included in the balance of unrecognized tax benefits at December 31, 2012 and 2011, respectively, are $3.3 million and $1.0 million of tax benefits that, if recognized, would result in adjustments to other tax accounts, primarily deferred taxes. No income tax benefit would be realized due to the company's valuation allowance position. We do not anticipate a significant change to the unrecognized tax benefits over the next twelve months.

        We are subject to taxation in the United States and in California. Because of net operating loss and research credit carryovers, substantially all of our tax years remain open to examination.

        Our policy is that we recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. We currently have no tax positions that would be subject to interest or penalties.