INCOME TAXES
The TCJA includes several changes to existing U.S. tax laws that impact us, most notably a reduction of the U.S. corporate income tax rate from 35% to 21%, which became effective January 1, 2018. We recognized the initial income tax effects of the TCJA in our 2017 financial statements in accordance with Staff Accounting Bulletin No. 118, which provides SEC staff guidance for the application of ASC 740, Income Taxes, in the reporting period in which the TCJA was signed into law. As such, our financial results reflect the income tax effects of the TCJA for which the accounting under ASC 740 is complete, as well as for provisional amounts for those specific income tax effects under ASC 740 that are incomplete, but a reasonable estimate could be determined. We did not identify any items for which the income tax effects of the TCJA have not been completed and a reasonable estimate could not be determined as of December 31, 2017.
As of December 31, 2017, we recorded provisional charges related to the remeasurement of the deferred tax assets and liabilities due to the reduction in the corporate tax rate. Examples of unavailable or unanalyzed information for which we have provisional estimates include deferred taxes related to depreciation (including lease financing), partnership earnings, and realized built-in losses from a prior acquisition. These estimates are subject to change as additional data is gathered, as interpretations and guidance are received, and as the final analyses are completed. The measurement period ends when we have analyzed the information necessary to finalize our accounting, but cannot extend beyond one year.
The effects of changes in tax rates on deferred tax balances are applicable even in situations in which the related income tax effects of such items were originally recognized in other comprehensive income. This results in stranded tax effects for items that were recorded in AOCI rather than in income from continuing operations. In the fourth quarter of 2017, we elected to change our accounting policy to reclassify the income tax effects related to the TCJA of approximately $14.7 million from AOCI to retained earnings. This change in accounting policy results in the appropriate tax rate being recognized in AOCI for debt and equity investments, certain derivative transactions, and pension and other post-retirement benefit plans.
Income Tax Expense
Federal and state income tax expense consist of the following:
|
| | | | | | | | | | | |
Year Ended December 31 | 2017 | | 2016 | | 2015 |
(in thousands) | | | | | |
Current income taxes: | | | | | |
Federal taxes | $ | 26,336 |
| | $ | 57,894 |
| | $ | 69,572 |
|
State taxes | 1,746 |
| | 2,329 |
| | 989 |
|
Total current income taxes | 28,082 |
| | 60,223 |
| | 70,561 |
|
Deferred income taxes: | | | | | |
Federal taxes | 128,204 |
| | 14,983 |
| | 63 |
|
State taxes | 779 |
| | 291 |
| | (631 | ) |
Total deferred income taxes | 128,983 |
| | 15,274 |
| | (568 | ) |
Total income taxes | $ | 157,065 |
| | $ | 75,497 |
| | $ | 69,993 |
|
The following table provides a reconciliation between the statutory tax rate and the actual effective tax rate:
|
| | | | | | | | |
Year Ended December 31 | 2017 | | 2016 | | 2015 |
Statutory tax rate | 35.0 | % | | 35.0 | % | | 35.0 | % |
State taxes, net of federal benefit | 0.5 |
| | 0.7 |
| | 0.8 |
|
Valuation allowance reversal | — |
| | — |
| | (0.8 | ) |
Tax-exempt interest | (3.3 | ) | | (2.9 | ) | | (2.2 | ) |
Cash surrender value on BOLI | (1.1 | ) | | (1.5 | ) | | (1.3 | ) |
Tax credits | (2.6 | ) | | (0.9 | ) | | (1.1 | ) |
Affordable housing cost amortization, net of tax benefits | 0.2 |
| | — |
| | — |
|
Tax Cuts and Jobs Act revaluation of net deferred tax assets | 15.2 |
| | — |
| | — |
|
Other items | 0.2 |
| | 0.2 |
| | 0.1 |
|
Actual effective tax rate | 44.1 | % | | 30.6 | % | | 30.5 | % |
The effective tax rate for 2017 was 44.1%, as compared to 30.6% in 2016. The higher rate is largely due to $54.0 million of income tax expense recorded from the revaluation of net deferred tax assets in connection the TCJA, partially offset by increased tax credit activity in 2017. The effective tax rates for 2016 and 2015 were lower than the statutory tax rate due to tax benefits resulting from tax-exempt income on investments, loans, tax credits and income from bank-owned life insurance (BOLI).
Income tax expense related to gains on the sale of securities is presented in the following table:
|
| | | | | | | | | | | |
Year Ended December 31 | 2017 | | 2016 | | 2015 |
(in thousands) | | | | | |
Income tax expense related to gains on sale of securities | $ | 2,071 |
| | $ | 249 |
| | $ | 288 |
|
Deferred Income Taxes
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and tax purposes. Deferred tax assets and liabilities are measured based on the enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. As such, during December 2017, we remeasured our deferred tax assets and liabilities as a result of the passage of the TCJA. The primary impact of this remeasurement was a reduction in deferred tax assets and liabilities in connection with the reduction of the U.S. corporate income tax rate from 35% to 21%.
The following table presents the tax effects of significant temporary differences that give rise to federal and state deferred tax assets and liabilities:
|
| | | | | | | |
December 31 | 2017 | | 2016 |
(in thousands) | | | |
Deferred tax assets: | | | |
Allowance for credit losses | $ | 38,933 |
| | $ | 56,090 |
|
Discounts on acquired loans | 64,341 |
| | 48,978 |
|
Net operating loss/tax credit carryforwards | 47,376 |
| | 17,753 |
|
Deferred compensation | 8,534 |
| | 12,236 |
|
Securities impairments | 1,092 |
| | — |
|
Pension and other defined benefit plans | 6,768 |
| | 7,713 |
|
Net unrealized securities losses | 7,238 |
| | 6,972 |
|
Other | 7,787 |
| | 11,264 |
|
Total | 182,069 |
| | 161,006 |
|
Valuation allowance | (26,620 | ) | | (18,945 | ) |
Total deferred tax assets | 155,449 |
| | 142,061 |
|
Deferred tax liabilities: | | | |
Loan costs | (7,211 | ) | | (2,222 | ) |
Depreciation | (12,263 | ) | | (12,392 | ) |
Prepaid expenses | (3,669 | ) | | (682 | ) |
Amortizable intangibles | (18,422 | ) | | (18,506 | ) |
Lease financing | (10,035 | ) | | (5,538 | ) |
Debt discharge income deferral | (474 | ) | | (1,361 | ) |
Originated mortgage servicing rights | (6,178 | ) | | (748 | ) |
Net unrealized securities gains | — |
| | (86 | ) |
Other | (1,647 | ) | | (1,253 | ) |
Total deferred tax liabilities | (59,899 | ) | | (42,788 | ) |
Net deferred tax assets | $ | 95,550 |
| | $ | 99,273 |
|
We establish a valuation allowance when it is more likely than not that we will not be able to realize the benefit of the deferred tax assets or when future deductibility is uncertain. Periodically, the valuation allowance is reviewed and adjusted based on management’s assessment of realizable deferred tax assets. As of December 31, 2017, the valuation allowance primarily relates to unused federal and state net operating loss carryforwards expiring from 2018 to 2037. We anticipate that neither the state net operating loss carryforwards nor the other net deferred tax assets at certain of our subsidiaries will be utilized and, as such, has recorded a valuation allowance against the deferred tax assets related to these carryforwards.
As of December 31, 2017, we had approximately $65.5 million of federal net operating loss and built-in loss carryforwards, $5.2 million of federal tax credit carryforwards, and $21.5 million of state net operating loss carryforwards to which we succeeded as a result of the YDKN acquisition. The utilization of these tax attributes is subject to annual limitations under Section 382 of the Internal Revenue Code, or a similar state-level statute, which will cause the utilization of these attributes to be deferred over a number of years, not to exceed beyond 2036. We have determined that we will likely have sufficient taxable income in the years during which these tax attributes are available to be utilized and, consequently, have determined that no valuation allowance against the recorded deferred tax asset is warranted.
Unrecognized Tax Benefits
A reconciliation of the beginning and ending amount of unrecognized tax benefits (excluding interest and the federal income tax benefit of unrecognized state tax benefits) is as follows:
|
| | | | | | | |
Year Ended December 31 | 2017 | | 2016 |
(in thousands) | | | |
Balance at beginning of year | $ | 542 |
| | $ | 455 |
|
Additions based on tax positions related to current year | 186 |
| | 163 |
|
Additions based on tax positions of prior year | — |
| | — |
|
Reductions for tax positions of prior years | (5 | ) | | — |
|
Reductions due to expiration of statute of limitations | (73 | ) | | (76 | ) |
Balance at end of year | $ | 650 |
| | $ | 542 |
|
As of December 31, 2017 and 2016, we have approximately $0.7 million and $0.5 million, respectively, of unrecognized tax benefits, excluding interest and the federal tax benefit of unrecognized state tax benefits. Also, as of December 31, 2017 and 2016, additional unrecognized tax benefits relating to accrued interest, net of the related federal tax benefit, amounted to $25,000 and $19,000, respectively. As of December 31, 2017, $0.5 million of these tax benefits would affect the effective tax rate if recognized. We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. To the extent interest is not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.
We file numerous income tax returns in the U.S. federal jurisdiction and in several state jurisdictions. We are no longer subject to U.S. federal income tax examinations for years prior to 2014. With limited exception, we are no longer subject to state income tax examinations for years prior to 2014. We anticipate that a reduction in the unrecognized tax benefit of up to $81 thousand may occur in the next twelve months from the expiration of statutes of limitations which would result in a reduction in income taxes.