Lexeo Therapeutics, Inc. Income Taxes Disclosure

10. Income Taxes

The Company's effective tax rate includes the effects of state and local income taxes, net of the federal income tax benefit, which are primarily attributable to New York and New York City, where the Company has significant business activities. This state has higher effective tax rates compared to other jurisdictions where the Company operates, and together, it accounts for more than half of the Company's total state tax expense.

As of December 31, 2025 and 2024, the Company had federal net operating loss ("NOL") carryforwards of approximately $182.0 million and $106.4 million, respectively, which can be carried forward indefinitely. As of December 31, 2025 and 2024, the Company had state and local net operating loss carryforwards of approximately $362.9 million and $212.7 million, respectively, which begin to expire in 2040.

As of December 31, 2025 and 2024, the Company had federal tax credits of $7.2 million and $10.7 million, respectively, which begin to expire in 2040.

The Tax Cuts and Jobs Act (the "TCJA") resulted in significant changes to the treatment of research and developmental (“R&D”) expenditures under Section 174 of the Internal Revenue Code of 1986, as amended (the "IRC"). For tax years beginning after December 31, 2021, taxpayers are required to capitalize and amortize all R&D expenditures that are paid or incurred in connection with their trade or business. Specifically, costs for U.S.-based R&D activities must be amortized over five years and costs for foreign R&D activities must be amortized over 15 years, both using a midyear convention.

For tax years beginning after December 31, 2024, the One Big Beautiful Bill Act enacted a new rule under Section 174A of the IRC allowing companies to immediately expense any domestic R&D expenditures. For domestic R&D, companies may either immediately expense or elect to capitalize and amortize over at least 60 months under Section 174A of the IRC. However, foreign R&D continues to require capitalization subject to the mandatory 15-year amortization period under Section 174 of the IRC.

For domestic R&D expenditures that were previously capitalized in tax years 2022-2024 under the prior TCJA, companies may elect to recover the remaining unamortized balance by either (1) expensing fully in the first year beginning after December 31, 2024, (2) expensing ratably over two years beginning after December 31, 2024, or (3) continue amortizing over the remaining life.

The Company has elected to continue amortizing the previously capitalized costs over their remaining life. Beginning in tax year 2025, instead of immediately expensing domestic R&D expenditures under Section 174A of the IRC, the Company elected to capitalize and amortize its domestic R&D expenditures under Section 59(e) of the IRC over a 10-year period. Any foreign R&D costs will continue to be capitalized and amortized over 15 years in accordance with the requirements of Section 174 of the IRC.

Future realization of the tax benefits of existing temporary differences and net operating loss carryforwards ultimately depends on the existence of sufficient taxable income within the carryforward period. As of December 31, 2025 and December 31, 2024, the Company performed an evaluation to determine whether a valuation allowance was needed. The Company considered all available evidence, both positive and negative, which included the results of operations for the current and preceding years. The Company determined that it was not possible to reasonably quantify future taxable income and determined that it is more likely than not that all of the deferred tax assets will not be realized. As a result, the Company increased its valuation allowance by $23.5 million as of December 31, 2025.

The utilization of NOLs and tax credit carryforwards to offset future taxable income may be subject to an annual limitation as a result of ownership changes that have occurred previously or may occur in the future. Under Sections 382 and 383 of the IRC, a corporation that undergoes an ownership change may be subject to limitations on its ability to utilize its pre-change NOLs and other tax attributes otherwise available to offset future taxable income and/or tax liability. An ownership change is defined as a cumulative change of 50% or more in the ownership positions of certain stockholders during a rolling three-year period.

The Company conducted ownership analyses under IRC Section 382 as of September 30, 2024 and December 31, 2025 and determined the Company experienced ownership changes on November 7, 2023 and May 28, 2025, respectively, that limit the Company’s ability to utilize its federal NOLs and tax credits. As a result of the ownership changes, the Company is subject to an annual limitation of approximately $2.4 million on its ability to utilize its federal NOLs and tax credits recognized before May 28, 2025, inclusive of the ownership change that occurred on November 7, 2023. Due to the limitations, no federal NOLs are expected to expire unutilized and $10.6 million of federal tax credits that had been available to offset future tax liabilities, prior to the date of the ownership changes, are expected to expire unutilized. As a result, during the year ended December 31, 2025, the Company reduced its deferred tax assets related to the federal tax credits, which was offset by a corresponding decrease in the valuation allowance.

The calculation of the Company's tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations for both federal taxes and the many states in which it operates or does business in. ASC 740 states that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits.

The Company records uncertain tax positions as liabilities in accordance with ASC 740 and adjusts these liabilities when its judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the Company's current estimate of the unrecognized tax benefit liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information is available. As of December 31, 2025 and December 31, 2024, the Company has not recorded any uncertain tax positions in its financial statements.

The Company recognizes interest and penalties related to uncertain tax positions on the income tax expense line in the accompanying statements of operations. As of December 31, 2025 and December 31, 2024, no accrued interest or penalties are included on the related tax liability line in the balance sheet.

The Company files tax returns as prescribed by the tax laws of the jurisdictions in which it operates. In the normal course of business, the Company is subject to examination by federal and state jurisdictions, where applicable. The resolution of tax matters is not expected to have a material effect on the Company's financial statements. The Company’s tax years remain open under statute from December 31, 2022 to the present.