1ST SOURCE CORP

Income Taxes

The following table shows the composition of income tax expense.



Year Ended December 31 (Dollars in thousands)	2017			2016		2015
Current:
Federal	$	26,012		$	25,479	$	26,092
State	4,530			3,005		3,365
Total current	30,542			28,484		29,457
Deferred:
Federal	5,869			2,530		1,577
State	(488		)	326		43
Deferred tax liability remeasurement	(2,614		)	—		—
Total deferred	2,767			2,856		1,620
Total provision	$	33,309		$	31,340	$	31,077

The following table shows the reasons for the difference between income tax expense and the amount computed by applying the statutory federal income tax rate (35%) to income before income taxes.



	2017					2016					2015
Year Ended December 31 (Dollars in thousands)	Amount			Percent of Pretax Income		Amount			Percent of Pretax Income		Amount			Percent of Pretax Income
Statutory federal income tax	$	35,476		35.0	%	$	31,194		35.0	%	$	30,997		35.0	%
(Decrease) increase in income taxes resulting from:
Tax-exempt interest income	(1,197		)	(1.2	)	(1,235		)	(1.4	)	(1,152		)	(1.3	)
State taxes, net of federal income tax benefit	2,627			2.6		2,165			2.4		2,215			2.5
Deferred tax liability remeasurement	(2,614		)	(2.6	)	—			—		—			—
Other	(983		)	(0.9	)	(784		)	(0.8	)	(983		)	(1.1	)
Total	$	33,309		32.9	%	$	31,340		35.2	%	$	31,077		35.1	%

The tax expense related to gains on investment securities available-for-sale for the years 2017, 2016, and 2015 was approximately $1,629,000, $674,000, and $2,000, respectively.

The following table shows the composition of deferred tax assets and liabilities as of December 31, 2017 and 2016.



(Dollars in thousands)	2017			2016
Deferred tax assets:
Reserve for loan and lease losses	$	23,791		$	34,663
Accruals for employee benefits	2,369			3,948
Tax advantaged partnerships	—			1,411
Net unrealized losses on securities available-for-sale	1,285			—
Other	622			477
Total deferred tax assets	28,067			40,499
Deferred tax liabilities:
Differing depreciable bases in premises and leased equipment	22,641			31,449
Net unrealized gains on securities available-for-sale	—			807
Differing bases in assets related to acquisitions	3,954			6,170
Tax advantaged partnerships	1,921			—
Mortgage servicing	745			1,540
Capitalized loan costs	867			1,463
Prepaid expenses	387			646
Other	222			419
Total deferred tax liabilities	30,737			42,494
Net deferred tax liability	$	(2,670	)	$	(1,995	)

No valuation allowance for deferred tax assets was recorded at December 31, 2017 and 2016 as the Company believes it is more likely than not that all of the deferred tax assets will be realized.

The following table shows a reconciliation of the beginning and ending amounts of unrecognized tax benefits.



(Dollars in thousands)	2017		2016		2015
Balance, beginning of year	$	762	$	380	$	—
Additions based on tax positions related to the current year	350		382		380
Additions for tax positions of prior years	—		—		—
Reductions for tax positions of prior years	—		—		—
Reductions due to lapse in statute of limitations	—		—		—
Settlements	—		—		—
Balance, end of year	$	1,112	$	762	$	380

The total amount of unrecognized tax benefits that would affect the effective tax rate if recognized was $0.72 million at December 31, 2017, $0.50 million at December 31, 2016, and $0.25 million at December 31, 2015. Interest and penalties are recognized through the income tax provision. For the years 2017, 2016 and 2015, the Company recognized approximately $0.05 million, $0.04 million and $0.00 million in interest, net of tax effect, and penalties, respectively. There was $0.09 million, $0.04 million and $0.00 million accrued interest and penalties at December 31, 2017, 2016 and 2015, respectively.

Tax years that remain open and subject to audit include the federal 2014-2017 years and the Indiana 2014-2017 years. The Company does not anticipate a significant change in the amount of uncertain tax positions within the next 12 months.

The Tax Cuts and Jobs Act was enacted on December 22, 2017. The Act reduces the U.S. federal corporate tax rate from 35% to 21%. At December 31, 2017, the Company had not completed its accounting for the tax effects of enactment of the Act; however, in certain cases, as described below, the Company made a reasonable estimate of the effects on its existing deferred tax balances. The Company will continue to make and refine its calculations as additional analysis is completed. In addition, the Company’s estimates may also be affected as it gains a more thorough understanding of the tax law.

Provisional amounts

Deferred tax assets and liabilities: The Company remeasured certain deferred tax assets and liabilities based on the rates at which it expects to reverse in the future, which is generally 21%. However, the Company is still analyzing certain aspects of the Act and refining its calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. The provisional amount recorded related to the remeasurement of its deferred tax balance was a benefit of $2.61 million, which is included as a component of Income Tax Expense in the Consolidated Statements of Income and decreased the effective tax rate by 2.6%.

Further, at December 31, 2017, the Company was unable to fully revalue the deferred tax liabilities associated with its partnership investments in renewable energy and affordable housing and estimated the deferred tax liability associated with those projects to be $1.92 million. This estimation was necessary due to incomplete information for 2017 operations from those partnerships at year end. Upon receipt of the partnership Form 1065 K-1’s, the Company will complete the revaluation of those related deferred tax liabilities as provided by the U.S. Securities and Exchange Commission’s SAB No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act.