FIRST MIDWEST BANCORP INC

INCOME TAXES

Components of Income Tax Expense

(Dollar amounts in thousands)



	Years Ended December 31,
	2017			2016			2015
Current income tax expense:
Federal	$	93,540		$	46,748		$	18,524
State	104			790			2,326
Total	93,644			47,538			20,850
Deferred income tax (benefit) expense:
Federal	(12,219		)	(7,786		)	12,048
State	8,142			6,419			4,849
Total	(4,077		)	(1,367		)	16,897
Total income tax expense	$	89,567		$	46,171		$	37,747

The Tax Cuts and Jobs Act ("federal income tax reform") was enacted on December 22, 2017. Among other things, the new law (i) establishes a new, flat corporate federal statutory income tax rate of 21%, (ii) eliminates the corporate alternative minimum tax ("AMT") and allows the use of any such carryforwards to offset regular tax liability for any taxable year, (iii) limits the deduction for net interest expense incurred by U.S. corporations, (iv) allows businesses to immediately expense, for tax purposes, the cost of new investments in certain qualified depreciable assets, (v) eliminates or reduces certain deductions related to meals and entertainment expenses, (vi) modifies the limitation on excessive employee remuneration to eliminate the exception for performance-based compensation and clarifies the definition of a covered employee, and (vii) limits the deductibility of deposit insurance premiums. Federal income tax reform also significantly changes U.S. tax law related to foreign operations, however, such changes do not currently impact the Company.

On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 ("SAB 118") to address the application of U.S. GAAP in situations when an entity does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of federal income tax reform. SAB 118 provides guidance on accounting for the effects of federal income tax reform where the Company's determinations are incomplete but the Company is able to determine a reasonable estimate. A final determination is required to be made within a measurement period not to extend beyond one year from the enactment date of federal income tax reform.

As of December 31, 2017, the Company has completed the majority of its accounting for the tax effects of federal income tax reform. The Company has recognized provisional adjustments for the revaluation of deferred tax assets to reflect the reduced rate that will apply in future periods when these deferred taxes are settled and realized. Although the tax rate reduction is known, the Company has not fully collected all of the necessary data to complete its analysis of the effect of federal income tax reform on the underlying deferred taxes and as such, the amounts recorded as of December 31, 2017 are provisional. Any subsequent adjustment to these amounts, if any, will be recorded to income tax expense during 2018.

Federal income tax expense and the related effective income tax rate are influenced by the amount of tax-exempt income derived from investment securities and BOLI in relation to pre-tax income as well as state income taxes. 2017 current federal income tax expense included $26.6 million for the fourth quarter revaluation of deferred tax assets as a result of federal income tax reform. This revaluation adjustment remains preliminary and may change as the Company completes the accounting for the federal income tax reform. State income tax expense and the related effective income tax rate are driven by both the amount of state tax-exempt income in relation to pre-tax income and state tax rules for consolidated/combined reporting and sourcing of income and expense. 2017 current state income tax included a $2.8 million benefit recorded in the third quarter due to a change in the Illinois income tax rate.

Components of Effective Tax Rate

(Dollar amounts in thousands)



	Years Ended December 31,
	2017					2016					2015
	Amount			% of Pretax Income		Amount			% of Pretax Income		Amount			% of Pretax Income
Statutory federal income tax	$	65,784		35.0	%	$	48,482		35.0	%	$	41,934		35.0	%
Increase (decrease) in income taxes resulting from:
Revaluation of deferred tax assets	23,709			12.6		—			—		—			—
Tax-exempt income, net of interest expense disallowance	(5,065		)	(2.7	)	(5,439		)	(3.9	)	(6,752		)	(5.6	)
State income tax, net of federal income tax effect	5,069			2.7		4,323			3.1		4,665			3.9
Other	70			0.1		(1,195		)	(0.9	)	(2,100		)	(1.8	)
Total	$	89,567		47.7	%	$	46,171		33.3	%	$	37,747		31.5	%

The increase in income tax expense and the effective tax rate from the years ended December 31, 2016 to 2017 was due primarily to higher pre-tax income subject to tax at statutory rates, the $26.6 million downward revaluation of deferred tax assets as a result of federal income tax reform, partly offset by a $2.8 million benefit due to a change in the Illinois income tax rate. The increase in income tax expense and the effective tax rate from the years ended December 31, 2015 to 2016 resulted primarily from an increase in income subject to tax at statutory rates, partially offset by decreases in state statutory rates.

As of December 31, 2017, 2016, and 2015, the Company's retained earnings included an appropriation for an acquired thrift's tax bad debt reserves of approximately $2.5 million for which no provision for federal or state income taxes has been made. If, in the future, this portion of retained earnings were distributed as a result of the liquidation of the Company or its subsidiaries, federal and state income taxes would be imposed at the then applicable rates.

Differences between the amounts reported in the consolidated financial statements and the tax basis of assets and liabilities result in temporary differences for which deferred tax assets and liabilities were recorded.

Deferred Tax Assets and Liabilities

(Dollar amounts in thousands)



	As of December 31,
	2017			2016
Deferred tax assets:
Allowance for credit losses	$	20,285		$	30,399
Deferred gain on sale-leaseback transaction	15,668			28,133
Equity based compensation	3,605			5,228
Federal and state net operating loss ("NOL") carryforwards	3,384			388
Acquisition adjustments	2,489			—
OREO	2,089			4,336
Non-equity based compensation	897			6,060
AMT and other credit carryforwards	667			90
Unrealized losses on securities	23			18,320
Other	12,494			10,997
Total deferred tax assets	61,601			103,951
Deferred tax liabilities:
Deferred loan fees and costs	(4,169		)	(3,172		)
Accrued retirement benefits	(3,517		)	(6,281		)
Fixed assets	(1,660		)	(397		)
Cancellation of indebtedness income	(641		)	(2,136		)
Acquisition adjustments	—			(13,407		)
Other	(2,449		)	(6,045		)
Total deferred tax liabilities	(12,436		)	(31,438		)
Deferred tax valuation allowance	—			—
Net deferred tax assets	49,165			72,513
Tax effect of adjustments related to other comprehensive income (loss)	15,571			27,694
Net deferred tax assets including adjustments	$	64,736		$	100,207
NOL carryforwards available to offset future taxable income:
Federal gross NOL carryforwards, begin to expire in 2035	$	—		$	574
Illinois gross NOL carryforwards, begin to expire in 2025	188,995			26,342
Indiana gross NOL carryforwards, begin to expire in 2025	16,174			1,003
AMT credits	410			—

During the year ended December 31, 2017, the Company recorded net deferred tax assets of $41.5 million related to the Standard acquisition and a measurement period adjustment related to finalizing the fair values of the assets acquired and liabilities assumed in the NI Bancshares acquisition. During the year ended December 31, 2016, the Company recorded net deferred tax assets of $4.4 million related to the NI Bancshares acquisition and a measurement period adjustment related to finalizing the fair values of the assets acquired and liabilities assumed in the Peoples acquisition.

During the years ended December 31, 2017 and 2016, the Company transferred certain loans into Real Estate Mortgage Investment Conduit trusts which are classified as loans in the financial statements and as securities for tax purposes.

Net deferred tax assets are included in other assets in the accompanying Consolidated Statements of Financial Condition. Management believes that it is more likely than not that net deferred tax assets will be fully realized and no valuation allowance is required.

Uncertainty in Income Taxes

The Company files a U.S. federal income tax return and state income tax returns in various states. Income tax returns filed by the Company are no longer subject to examination by federal and state income tax authorities for years prior to 2014.

Rollforward of Unrecognized Tax Benefits

(Dollar amounts in thousands)



	Years Ended December 31,
	2017			2016			2015
Beginning balance	$	2,039		$	1,408		$	912
Additions for tax positions relating to the current year	845			640			480
Additions for tax positions relating to prior years	13,389			—			37
Reductions for tax positions relating to prior years	(25		)	(9		)	(21		)
Ending balance	$	16,248		$	2,039		$	1,408
Interest and penalties not included above ⁽¹⁾:
Interest expense, net of tax effect, and penalties	$	118		$	49		$	20
Accrued interest and penalties, net of tax effect, at end of year	191			73			24


⁽¹⁾	Included in income tax expense in the Consolidated Statements of Income.

The Company does not anticipate that the amount of uncertain tax positions will significantly increase or decrease in the next twelve months. Included in the balance as of December 31, 2017, 2016, and 2015 are tax positions totaling $12.9 million, $1.4 million and $936,000, respectively, which would favorably affect the Company's effective tax rate if recognized in future periods.