A population of axial stem cells present in the caudal lateral epiblast of the mouse embryo is known to produce both neural plate and mesoderm cells, but the factors regulating this choice are unknown. Takemoto et al. now show that Tbx6-dependent modulation of the developmental transcription factor Sox2 drives the fate of these axial stem cells. In the absence of Tbx6, cells aberrantly upregulated Sox2 activity, meaning that cells originally destined to be mesoderm turned into ectopic neural tubes. This work and recent cell-lineage analyses challenge the textbook view that segregation of the three germ layers (ectoderm, mesoderm, endoderm) is the process specifying cell lineages in early embryos. Rather, the paraxial mesoderm (producing muscle and bone) and neural plate (producing the brain and spinal cord) seem to be derived from common stem-cell-like precursors. A common stem cell is known to produce both neural plate and mesoderm, but the factors regulating this choice are unknown. This study determines that Tbx6-dependent modulation of the developmental transcription factor Sox2 drives the fate of axial stem cells. In the absence of Tbx6, cells aberrantly upregulated Sox2 activity, with the result that cells originally destined to be mesoderm turned into ectopic neural tubes. In the absence of the N1 enhancer, this aberrant regulation is corrected and cells follow the appropriate fate, even in the absence of Tbx6. Therefore, active repression of the neural fate program is essential for mesoderm tissue to develop from axial stem cells. The classical view of neural plate development held that it arises from the ectoderm, after its separation from the mesodermal and endodermal lineages. However, recent cell-lineage-tracing experiments indicate that the caudal neural plate and paraxial mesoderm are generated from common bipotential axial stem cells originating from the caudal lateral epiblast1,2. Tbx6 null mutant mouse embryos which produce ectopic neural tubes at the expense of paraxial mesoderm3 must provide a clue to the regulatory mechanism underlying this neural versus mesodermal fate choice. Here we demonstrate that Tbx6-dependent regulation of Sox2 determines the fate of axial stem cells. In wild-type embryos, enhancer N1 of the neural primordial gene Sox2 is activated in the caudal lateral epiblast, and the cells staying in the superficial layer sustain N1 activity and activate Sox2 expression in the neural plate4,5,6. In contrast, the cells destined to become mesoderm activate Tbx6 and turn off enhancer N1 before migrating into the paraxial mesoderm compartment. In Tbx6 mutant embryos, however, enhancer N1 activity persists in the paraxial mesoderm compartment, eliciting ectopic Sox2 activation and transforming the paraxial mesoderm into neural tubes. An enhancer-N1-specific deletion mutation introduced into Tbx6 mutant embryos prevented this Sox2 activation in the mesodermal compartment and subsequent development of ectopic neural tubes, indicating that Tbx6 regulates Sox2 via enhancer N1. Tbx6-dependent repression of Wnt3a in the paraxial mesodermal compartment is implicated in this regulatory process. Paraxial mesoderm-specific misexpression of a Sox2 transgene in wild-type embryos resulted in ectopic neural tube development. Thus, Tbx6 represses Sox2 by inactivating enhancer N1 to inhibit neural development, and this is an essential step for the specification of paraxial mesoderm from the axial stem cells.