Income Taxes

Lexicon recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been recognized differently in the financial statements and tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement carrying amounts and tax bases of liabilities and assets using enacted tax rates and laws in effect in the years in which the differences are expected to reverse. Deferred tax assets are evaluated for realization based on a more-likely-than-not criteria in determining if a valuation allowance should be provided.

The components of Lexicon’s deferred tax assets (liabilities) at December 31, 2016 and 2015 are as follows:



	As of December 31,
	2016			2015
	(in thousands)
Deferred tax assets:
Net operating loss carryforwards	$	258,405		$	263,138
Research and development tax credits	44,111			43,728
Orphan drug credits	24,233			—
Capitalized research and development	86,845			85,385
Stock-based compensation	7,060			8,160
Deferred revenue	39,307			4,363
Other	8,432			8,831
Total deferred tax assets	468,393			413,605
Deferred tax liabilities:
Deferred tax liability related to acquisition of Symphony Icon	(18,675		)	(18,675		)
Total deferred tax liabilities	(18,675		)	(18,675		)
Less: valuation allowance	(468,393		)	(413,605		)
Net deferred tax liabilities	$	(18,675	)	$	(18,675	)

The $18.7 million deferred tax liability relates to the tax impact of future amortization or possible impairments associated with intangible assets acquired with Symphony Icon, which are not deductible for tax purposes. Lexicon does not believe it can estimate the reversal of the temporary difference related to the assets acquired with sufficient certainty such that the related deferred tax liability could be considered as a source of taxable income in assessing the Company’s need for a valuation allowance.

At December 31, 2016, Lexicon had both federal and state NOL carryforwards of approximately $725.9 million and $315.4 million, respectively. The federal and state NOL carryforwards will begin to expire in 2018. The Company’s R&D tax credit carryforwards of approximately $44.1 million began to expire in 2018. The orphan drug credit relates to a credit that is calculated as a percentage of expenditures for development of XERMELO, which has received Orphan Drug designation from the FDA. Utilization of the NOL, R&D credit and orphan drug credit carryforwards may be subject to a significant annual limitation due to ownership changes that have occurred previously or could occur in the future provided by Section 382 of the Internal Revenue Code. Based on the federal tax law limits and the Company’s cumulative loss position, Lexicon concluded it was appropriate to establish a full valuation allowance for its net deferred tax assets until an appropriate level of profitability is sustained. During the year ended December 31, 2016, the valuation allowance increased $54.8 million, primarily due to the Company’s current year net loss. Lexicon recorded income tax benefits of $0, $0 and $70,000 in the years ended December 31, 2016, 2015 and 2014, respectively. As of December 31, 2016 and 2015, the Company did not have any unrecognized tax benefits.

The Company is primarily subject to U.S. federal and New Jersey and Texas state income taxes. The tax years 1995 to current remain open to examination by U.S. federal authorities and 2004 to current remain open to examination by state authorities. The Company’s policy is to recognize interest and penalties related to income tax matters in income tax expense. As of December 31, 2016 and 2015, the Company had no accruals for interest or penalties related to income tax matters.