Income Taxes

The Tax Cuts and Jobs Act (the “2017 Tax Act”) was enacted on December 22, 2017. The 2017 Tax Act significantly changes U.S. corporate income tax laws, including reducing the U.S. corporate income tax rate from 35 percent to 21 percent beginning in 2018. At December 31, 2017, Lexicon has not completed the accounting for the tax effects of the 2017 Tax Act; however, an estimate of the effects on the existing deferred tax balances has been made, as further discussed below.

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. Accordingly, Lexicon remeasured certain deferred tax assets and liabilities based on the newly enacted U.S. corporate income tax rate, which resulted in a decrease of $171.4 million. Lexicon will continue to make and refine calculations and estimates, which could potentially affect the measurement of the deferred tax balances or give rise to new deferred tax amounts. Where the Company has not yet been able to make reasonable estimates of the impact of certain elements, the Company has not recorded any amounts related to those elements and has continued accounting for them in accordance with ASC 740 on the basis of the tax laws in effect immediately prior to the enactment of the 2017 Tax Act. 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, 2017 and 2016 are as follows:



	As of December 31,
	2017			2016
	(in thousands)
Deferred tax assets:
Net operating loss carryforwards	$	186,967		$	258,405
Research and development tax credits	46,682			44,111
Orphan drug credits	26,524			24,233
Capitalized research and development	69,561			86,845
Stock-based compensation	3,923			7,060
Deferred revenue	12,950			39,307
Other	5,579			8,432
Total deferred tax assets	352,186			468,393
Deferred tax liabilities:
Deferred tax liability related to acquisition of Symphony Icon	(10,896		)	(18,675		)
Other	(1		)	—
Total deferred tax liabilities	(10,897		)	(18,675		)
Less: valuation allowance	(347,303		)	(468,393		)
Net deferred tax liabilities	$	(6,014	)	$	(18,675	)

The $10.9 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. During 2017, after XERMELO was approved by the FDA, the intangible asset related to XERMELO became finite-lived and as a result $8.7 million of the related deferred tax liability could be considered as a source of taxable income. Lexicon does not believe it can estimate the reversal of the temporary difference related to the remaining assets acquired with sufficient certainty such that $6.0 million of the deferred tax liability is not considered as a source of taxable income in assessing the Company’s need for a valuation allowance in accordance with ASC 740 on the basis of the tax laws in effect immediately prior to the enactment of the 2017 Tax Act.

At December 31, 2017, Lexicon had both federal and state NOL carryforwards of approximately $851.4 million and $382.0 million, respectively. The federal and state NOL carryforwards will begin to expire in 2018. The Company’s R&D tax credit carryforwards of approximately $46.7 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, excluding the deferred tax liability relating to the XERMELO finite-lived asset, until an appropriate level of profitability is sustained. During the year ended December 31, 2017, the valuation allowance decreased $121.1 million, primarily due to the effect of the new U.S. federal corporate tax rate. Lexicon recorded income tax benefits of $12.7 million in the year ended December 31, 2017. Of the $12.7 million tax benefits, $8.7 million is the release of a valuation allowance as a result of the ability to estimate the reversal of the deferred tax liability related to the intangible associated with XERMELO, as discussed above. The remaining $4.0 million was recorded to remeasure the deferred tax liability associated with the remaining indefinite-lived intangible asset associated with Symphony Icon at the newly enacted U.S. corporate income tax rate. There were no income tax benefits in the years ended December 31, 2016 and 2015, respectively. As of December 31, 2017 and 2016, 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, 2017 and 2016, the Company had no accruals for interest or penalties related to income tax matters.