Lipocine Inc.

(7)

Income Taxes

(a)

Income Tax Expense

Income tax expense consists of:

	December 31,
	2017		2016		2015

U.S. federal	$	-	$	-	$	-
State and local		700		752		200
Deferred		-		-		-
Total	$	700	$	752	$	200

(b)

Tax Rate Reconciliation

Income tax expense was $700, $752 and $200, respectively, for the years ended December 31, 2017, 2016 and 2015 and differed from the amounts computed by applying the U.S. federal income tax rate of 34% to pretax income from continuing operations as a result of the following:

	December 31,
	2017		2016		2015

Computed "expected" tax expense (benefit)	$	(7,133,934)	$	(6,450,075)	$	(6,190,781)
Increase (reduction) in income taxes resulting from:
Change in valuation allowance		(6,173,708)		6,709,591		6,691,992
Difference associated with federal rate change		13,240,342		-		-
State and local income taxes, net of federal income tax benefit		462		496		132
Stock expense		684,854		200,002		102,221
Research and development tax credits		(394,470)		(337,968)		(452,609)
Orphan drug tax credit		(227,109)		(127,641)		(155,452)
Other, net		4,263		6,347		4,697
	$	700	$	752	$	200

(c)

Significant Components of Deferred Taxes

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2017 and 2016 are presented below.

	December 31,
	2017		2016

Deferred tax assets:
Stock-based compensation	$	1,330,706	$	1,924,260
Net operating loss carryforwards		25,395,518		30,700,358
Employee benefits		54,729		69,112
Research and development tax credits		3,012,081		2,465,893
Orphan drug tax credits		1,023,290		679,185
Other deductible tempory differences		104		70,231
Total gross deferred tax assets		30,816,428		35,909,039
Less valuation allowance		(30,813,270)		(35,904,927)
Net deferred tax assets		3,158		4,112
Deferred tax liabilities:
Plant and equipment		(3,158)		(4,112)
Total gross deferred tax liabilities		(3,158)		(4,112)
Net deferred tax liabilities	$	-	$	-

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“Tax Act”) was signed into law. The new law includes, among other items, a permanent reduction to the U.S. corporate income tax rate from 34% to 21% effective January 1, 2018. As a result, at December 31, 2017, we recognized a tax expense of $13.2 million from revaluing U.S net deferred tax assets which was offset by a corresponding change in the Company’s valuation allowance.

The valuation allowance for deferred tax assets as of December 31, 2017 and 2016 was $30.8 million and $35.9 million. The net change in the valuation allowance was a decrease of $5.1 million in 2017 and an increase $7.7 million in 2016. A valuation allowance has been provided for the full amount of the Company’s net deferred tax assets as the Company believes it is more likely than not that these benefits will not be realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax planning strategies in making this assessment.

During the year ended December 31, 2013, the Company experienced a change in ownership, as defined by the Internal Revenue Code, as amended (the “Code”) under Section 382. A change of ownership occurs when ownership of a company increases by more than 50 percentage points over a three-year testing period of certain stockholders. As a result of this ownership change we determined that our annual limitation on the utilization of our federal net operating loss (“NOL”) and credit carryforwards is approximately $1.1 million per year. We will only be able to utilize $20.2 million of our pre-ownership change NOL carryforwards and will forgo utilizing $5.5 million of our pre-ownership change NOL carryforwards and $1.2 million of our pre-change credit carryforwards as a result of this ownership change. We do not account for forgone NOL and credit carryovers in our deferred tax assets and only account for the NOL and credit carryforwards that will not expire unutilized as a result of the restrictions of Code Section 382.

As of December 31, 2017, we had NOL and research and development credit carryforwards for U.S. federal income tax reporting purposes of approximately $96.5 million and $2.0 million, respectively. Approximately $25.7 million of the NOL will expire between 2023 and 2033 and $70.8 million of the NOL will expire 2034 through 2037. The research and development credits will begin to expire in 2033 through 2037. The research and development credits will begin to expire in 2033 through 2037. We have orphan drug credit carry forwards of approximately $1.0 million which will expire if unused through 2037.

We also have state NOL and research and development credit carry-forwards of approximately $102.5 million and $971,000, respectively. Approximately $12.4 million of the Company's state NOL expires in 2018, $37.7 million expires between 2019 and 2029, and $52.4 million will expire in 2030 through 2033. The state research and development credits expire in 2023 through 2030.

The Company's federal and state income tax returns for December 31, 2014 through 2017 are open tax years.

A reconciliation of the beginning and ending amount of total unrecognized tax contingencies, excluding interest and penalties, for the years ended December 31, 2017 and 2016 are as follows:

	December 31,
	2017		2016

Balance, beginning of year	$	-	$	-

Balance, end of year	$	-	$	-